S-1/A 1 a2193887zs-1a.htm S-1/A

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As filed with the Securities and Exchange Commission on September 22, 2009

Registration No. 333-152871

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549


Amendment No. 8
to
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933


A123 Systems, Inc.
(Exact name of registrant as specified in its charter)

Delaware
(State or other jurisdiction of
incorporation or organization)
  3690
(Primary Standard Industrial
Classification Code Number)
  04-3583876
(I.R.S. Employer
Identification Number)

A123 Systems, Inc.
Arsenal on the Charles
321 Arsenal Street
Watertown, Massachusetts 02472
(617) 778-5700
(Address, including zip code, and telephone number, including
area code, of registrant's principal executive offices)


David P. Vieau
Chief Executive Officer
A123 Systems, Inc.
Arsenal on the Charles
321 Arsenal Street
Watertown, Massachusetts 02472
(617) 778-5700
(Name, address, including zip code, and telephone number, including area code, of agent for service)


Copies to:
John H. Chory, Esq.
Mark G. Borden, Esq.
Susan L. Mazur, Esq.
Wilmer Cutler Pickering Hale and Dorr LLP
1100 Winter Street, Suite 4650
Waltham, Massachusetts 02451
(781) 966-2000
  Keith F. Higgins, Esq.
Ropes & Gray LLP
One International Place
Boston, Massachusetts 02110
(617) 951-7000

           Approximate date of commencement of proposed sale to public: as soon as practicable after this Registration Statement is declared effective.

           If any of the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.    o

           If this form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.    o

           If this form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier registration statement for the same offering.    o

           If this form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier registration statement for the same offering.    o

           Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o   Accelerated filer o   Non-accelerated filer ý
(Do not check if a smaller reporting company)
  Smaller reporting company o

CALCULATION OF REGISTRATION FEE

   
Title of Each Class of
Securities to be Registered

  Amount to be
Registered(1)

  Estimated Maximum
Offering Price
per Share(2)

  Estimated Maximum
Aggregate
Offering
Price(2)

  Amount of
Registration
Fee(3)(4)

 
   
Common Stock, par value $0.001 per share     29,532,576   $ 11.50   $ 339,624,624   $ 16,065  
   
(1)
Includes 3,852,075 shares of common stock that may be purchased by the underwriters to cover over-allotments, if any.

(2)
Estimated solely for the purpose of computing the registration fee in accordance with Rule 457(a) under the Securities Act.

(3)
Calculated pursuant to Rule 457(a) based on a bona fide estimate of the maximum aggregate offering price.

(4)
A registration fee of $11,533 was previously paid in connection with this Registration Statement. Accordingly, the Registrant has paid an additional registration fee of $4,532.

           The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to Section 8(a), may determine.


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The information in this prospectus is not complete and may be changed. We and the selling stockholders may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and we and the selling stockholders are not soliciting offers to buy these securities in any jurisdiction where the offer or sale is not permitted.

PROSPECTUS (Subject to Completion)
Issued September 22, 2009

25,680,501 Shares

GRAPHIC

A123 Systems, Inc.

Common Stock



A123 Systems, Inc. is offering 25,000,000 shares of its common stock. The selling stockholders identified in this prospectus, which include members of our senior management, are offering an additional 680,501 shares. We will not receive any of the proceeds from the sale of the shares being sold by the selling stockholders. This is the initial public offering of shares of our common stock and no public market currently exists for our shares. We expect the initial public offering price of our common stock to be between $10.00 and $11.50 per share.



We have applied to list our common stock on The NASDAQ Global Market under the symbol "AONE".



Investing in our common stock involves risks. See "Risk Factors" beginning on page 10.



 
  Public
Offering
Price
  Underwriting
Discounts and
Commissions
  Proceeds
to us
  Proceeds
to Selling
Stockholders
Per Share   $                $                $                $             
Total   $                          $                      $                          $                       

We have granted the underwriters the right to purchase up to an additional 3,852,075 shares of common stock to cover over-allotments.

The Securities and Exchange Commission and state securities regulators have not approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

The underwriters expect to deliver the shares to purchasers on                        , 2009.



MORGAN STANLEY   GOLDMAN, SACHS & CO.



BOFA MERRILL LYNCH   DEUTSCHE BANK SECURITIES



LAZARD CAPITAL MARKETS   PACIFIC CREST SECURITIES

                           , 2009


LOGO


LOGO


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TABLE OF CONTENTS

PROSPECTUS SUMMARY

    1  

THE OFFERING

    7  

SUMMARY CONSOLIDATED FINANCIAL DATA

    8  

RISK FACTORS

    10  

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

    37  

USE OF PROCEEDS

    38  

DIVIDEND POLICY

    38  

CAPITALIZATION

    39  

DILUTION

    41  

SELECTED CONSOLIDATED FINANCIAL DATA

    43  

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

    46  

BUSINESS

    72  

MANAGEMENT

    95  

EXECUTIVE COMPENSATION

    103  

RELATED PERSON TRANSACTIONS

    120  

PRINCIPAL AND SELLING STOCKHOLDERS

    124  

DESCRIPTION OF CAPITAL STOCK

    127  

SHARES ELIGIBLE FOR FUTURE SALE

    130  

UNDERWRITERS

    132  

LEGAL MATTERS

    138  

EXPERTS

    138  

WHERE YOU CAN FIND MORE INFORMATION

    138  

CONSOLIDATED FINANCIAL STATEMENTS

    F-1  


        You should rely only on the information contained in this document and any free writing prospectus prepared by or on behalf of us or to which we have referred you. Neither we nor the selling stockholders have authorized anyone to provide you with information that is different. This prospectus may only be used where it is legal to sell these securities. The information in this prospectus may only be accurate on the date of this document.

        We have not taken any action to permit a public offering of the shares of common stock outside the United States or to permit the possession or distribution of this prospectus outside the United States. Persons outside the United States who come into possession of this prospectus must inform themselves about and observe any restrictions relating to the offering of the shares of common stock and the distribution of this prospectus outside the United States.

        Until                       , 2009 (25 days after the commencement of this offering), all dealers that buy, sell or trade our common stock, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the dealer's obligation to deliver a prospectus when acting as an underwriter and with respect to unsold allotments or subscriptions.

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PROSPECTUS SUMMARY

        This summary highlights information appearing elsewhere in this prospectus. This summary does not contain all of the information you should consider before investing in our common stock. You should read this entire prospectus carefully, especially the "Risk Factors" section beginning on page 10 and our consolidated financial statements and the related notes appearing elsewhere in this prospectus, before making an investment decision.

Overview

        We design, develop, manufacture and sell advanced, rechargeable lithium-ion batteries and battery systems. Our batteries and battery systems provide a combination of power, safety and life that we believe no other commercially available battery provides. We believe that lithium-ion batteries will play an increasingly important role in facilitating a shift toward cleaner forms of energy. Using our innovative approach to materials science and battery engineering and our systems integration and manufacturing capabilities, we have developed a broad family of high-power lithium-ion batteries and battery systems. This family of products, combined with our strategic partner relationships in the transportation, electric grid services and consumer markets, positions us well to address these markets for next-generation energy storage solutions.

        In our largest target market, the transportation industry, we are working with major global automotive manufacturers and tier 1 suppliers to develop batteries and battery systems for hybrid electric vehicles, or HEVs, plug-in hybrid electric vehicles, or PHEVs, and electric vehicles, or EVs. For example, we are designing and developing batteries and battery systems for BMW, Chrysler, GM, Shanghai Automotive Industry Corporation, or SAIC, Delphi and Better Place for multiple passenger vehicle models. Based on data from IHS Global Insight, we estimate that the number of HEV, PHEV and EV models with an annual production run of at least 20,000 vehicles will grow from 19 models in 2009 to over 150 models in 2014 and over 200 models in 2019. According to A.T. Kearney, the global lithium-ion battery market for automotive application in HEVs, PHEVs, and EVs is estimated to be $31.9 million in 2009. A.T. Kearney projects that this market will grow to approximately $21.8 billion by 2015 and $74.1 billion by 2020, based on a moderate drive for change influenced by increasing governmental regulation, emerging powertrain technology, changing consumer demand and OEM product strategies toward more fuel efficient vehicles.

        We are also implementing our battery technology for use in heavy-duty vehicles. We are engaged in design and development activities with five heavy-duty vehicle manufacturers and tier 1 suppliers regarding their HEV and EV development efforts for trucks and buses, and we have been selected to co-develop battery systems for several of them. For example, pursuant to our supply agreement with Magna Steyr, we are providing batteries for use in battery systems developed by Magna Steyr for deployment in the Volvo 7700 Hybrid bus. In addition, we have a development and supply agreement with BAE Systems, pursuant to which we are in volume production for battery systems for BAE Systems' Hybridrive propulsion system, which is currently being deployed in Daimler's Orion VII hybrid electric buses. We also have been selected to develop the battery system for an additional Daimler hybrid electric bus program.

        In addition to the development activities described above, we are bidding for programs with several other vehicle manufacturers to develop and/or supply batteries and battery systems for HEVs, PHEVs and EVs.

        Our cylindrical batteries are in volume production and are commercially available for use in automotive and heavy duty vehicles. Our next generation cylindrical batteries and our prismatic batteries are either in development or in prototype production and testing and have not yet been deployed by passenger vehicle manufacturers in commercial production vehicles. Our batteries for the transportation market have been commercially deployed in our Hymotion L5 battery range extender module and in both the Daimler Orion VII and Volvo 7700 hybrid buses.

        We are also developing battery systems that we believe will improve the reliability of the electric power grid. We are working with AES Energy Storage, LLC, a unit of AES Corporation, or AES, to

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engineer, manufacture and install multi-megawatt battery systems, called Hybrid Ancillary Power Units, or Hybrid-APUs, that provide electric grid ancillary services such as standby reserve capacity and frequency regulation services. Our products provide standby reserve capacity, by delivering power quickly in order to offset supply shortages caused by generator or transmission outages, and frequency regulation, by regulating the minute-to-minute frequency fluctuations in the grid that are caused by changes in supply and demand. The first of the AES systems, a two megawatt system housed in a 53-foot trailer, is installed at an AES facility, and we have shipped additional units for AES, totaling 16 megawatts.

        We are also focusing on the consumer market. We first commercialized our battery technologies for use in cordless power tools. Since 2006, we have supplied batteries to Black & Decker, a leading producer of power tools. Our batteries are used in Black & Decker's 36, 18, and 14.4 volt power tool lines. We have also entered into agreements with The Gillette Company, a wholly-owned subsidiary of The Procter & Gamble Company, to supply Gillette with materials and technology for use in their consumer products.

        During the year ended December 31, 2008, 18%, 76%, and 6% of our product revenue was derived from sales in the transportation, consumer, and electric grid markets, respectively. In the first half of 2009, 70% of our product revenue was derived from sales in the transportation market and 30% was derived from sales in the consumer market.

        Our proprietary technology includes nanoscale materials initially developed at and exclusively licensed from the Massachusetts Institute of Technology. We are developing new generations of this core nanophosphate technology, as well as other battery technologies, to achieve additional performance improvements and to expand the range of applications for our batteries. For example, we recently developed an ultra high power battery for Mercedes-Benz HighPerformanceEngines for use by the Vodafone McLaren Mercedes team that provides more than ten times the watts/kilogram, or w/kg, as compared to a standard Prius battery. Our research and development team comprises over 200 employees and has significant expertise in battery materials science, process engineering and battery-package engineering, as well as battery system design and integration. We own or exclusively license 45 issued patents and more than 200 pending patents in the United States and internationally.

        We intend to take advantage of U.S. government programs established to stimulate the economy and increase domestic investment in the battery industry. In February 2009, the U.S. government approved a stimulus program under the American Reinvestment and Recovery Act, or ARRA, which includes $2 billion of grants under the Department of Energy's Electric Drive Vehicle Battery and Component Manufacturing Initiative, or the DOE Battery Initiative, for the development of advanced batteries and electric drive components. In August 2009, the U.S. government announced that we have been selected to receive a $249.1 million grant award under the DOE Battery Initiative to fund the construction of new lithium-ion battery manufacturing facilities in Michigan. We have also applied for direct loans under the Department of Energy's $25 billion Advanced Technology Vehicles Manufacturing Loan Program, or the ATVM Program, to support this manufacturing expansion. Based on the amount of our grant award under the DOE Battery Initiative and the guidelines associated with the ATVM Program, we believe we will be permitted to borrow up to $235 million under the ATVM Program. Under the DOE Battery Initiative, we will be required to spend up to one dollar of our own funds for every incentive dollar we receive, and we expect we will be required to spend one dollar of our own funds for every four dollars we borrow under the ATVM Program. The timing and the amount of any loan we may receive under the ATVM Program, as well as the specific terms and conditions applicable to our grant award under the DOE Battery Initiative or any loan we may receive, are currently not known by us, and, once disclosed to us, are subject to change and negotiation with the federal government.

        The State of Michigan has awarded us a $10 million grant and offered us up to $4 million in low interest loans as an incentive to establish a lithium-ion battery manufacturing plant. We have received $3 million of the $10 million grant, with the remainder to be paid based on the achievement of certain milestones in our facility development. We intend to use these funds to support our planned expansion in Livonia, Michigan. In addition, in April 2009, the Michigan Economic Growth Authority, or MEGA,

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granted us a credit for 50% of our capital investment expenses, up to a maximum of $100 million over a four-year period, related to the construction of an integrated battery cell manufacturing plant, which we intend to build if we receive adequate funds from the DOE. We must create at least 300 jobs at the plant in order to receive this credit. MEGA has also offered us a 15-year tax credit, beginning with the 2011 fiscal year, having an estimated value of up to $25.3 million, depending on the number of jobs we create in Michigan.

        We perform most of our manufacturing at our facilities using our proprietary, high-volume process technologies. Our internal manufacturing operations allow us to directly control product quality and minimize the risks associated with disclosing proprietary technology to outside parties during production. We control every stage in the manufacture of our products except for the final assembly of one battery model and certain battery systems. Over the past several years, we have developed high-volume production expertise and manufacturing processes that we believe we can scale to meet increasing demands for our products. Our manufacturing processes can be modified to manufacture battery products for different applications and can be replicated to meet increasing customer demands. As of June 30, 2009, our annual manufacturing capacity was approximately 169 million watt hours. We have over 450,000 square feet of manufacturing facilities in China, Korea, Livonia, Michigan and Hopkinton, Massachusetts. If we receive sufficient federal and state incentive funding, we plan to expand our domestic battery manufacturing capacity. This expansion would complement our existing manufacturing facilities in Asia.

        We were incorporated in 2001. We were founded by Yet-Ming Chiang, Gilbert N. Riley, Jr. and Ric Fulop in order to commercialize new battery technology developed in Dr. Chiang's laboratory at the Massachusetts Institute of Technology. We began selling our first products commercially in the first quarter of 2006. We have approximately 1,700 employees worldwide. Since inception through June 30, 2009, we have generated $188.2 million in revenue consisting of $154.0 million in product revenue and $34.2 million in research and development revenue. Since inception through June 30, 2009, we have shipped 124.6 million Wh. Our revenue has grown from $34.3 million for the year ended December 31, 2006 to $41.3 million for the year ended December 31, 2007 to $68.5 million for the year ended December 31, 2008 and from $21.9 million for the six months ended June 30, 2008 to $42.9 million for the six months ended June 30, 2009. We experienced net losses of $15.8 million for 2006, $31.0 million for 2007, $80.5 million for 2008, and $40.7 million for the six months ended June 30, 2009.

Industry and Market Opportunity

        Global economic growth, geopolitical conflict in oil-producing regions and escalating exploration and production costs are increasing market demand for technologies that can help reduce dependence on oil. Meanwhile, heightened concerns about global warming and climate change are giving rise to stricter environmental standards and stronger regulatory support for energy sources that are not harmful to the environment. We believe these trends are contributing to the growing demand for advanced battery technologies in the transportation, electric grid services and consumer markets.

        In the transportation market, we believe the high prices of conventional fuel, greater awareness of environmental issues and government regulation are increasing the demand for HEVs, PHEVs and EVs. These vehicles offer improved gas mileage and reduced carbon emissions and may ultimately provide a vehicle alternative that eliminates the need for gasoline engines.

        Performance and reliability are essential to electric transmission and distribution grids. To preserve electric grid integrity, grid operators often need to call on resources to provide critical ancillary services such as reserve capacity and frequency regulation services. Traditionally, these grid services are provided by running select power plants on the grid below their full load capability so they can be called on and ramped up quickly as required. Advanced batteries capable of providing rapid charge and discharge cycles as well as high power and energy over a long calendar life can serve as a cost-effective alternative for reserve capacity and frequency regulation services.

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        Consumer applications that require high-power energy sources represent another attractive market for advanced batteries. Unlike batteries used in low-power consumer products such as laptops and cell phones, high-power batteries are designed not only to store large amounts of energy, but also to deliver it at very high power. Small, lightweight, high-power batteries with fast-charge capability can transform appliances, tools and equipment traditionally powered from electric outlets into more convenient, portable devices. These types of batteries are currently being used in cordless power tools and portable medical devices, with additional potential applications in home appliances, lawn and garden equipment and commercial cleaning equipment. Consumers continue to demand high-power batteries for portable applications that are smaller, lighter and longer lasting than those currently in use. With escalating environmental concerns around battery disposal, the market is also increasingly focused on replacing battery technologies that contain toxic metals such as nickel-cadmium or lead.

Our Solution

        Our solution is based on our proprietary nanophosphate chemistry and is supplemented with innovative battery designs as well as systems technologies that increase the performance of our battery systems. We believe our batteries and battery systems address the limitations of other currently available lithium-ion formulations and non lithium-ion energy storage technologies by offering the following:

    High power.  Our proprietary battery chemistry and design enable high electric power comparable to that available from ultra capacitor technology, a non-battery form of energy storage device. For example, we developed an ultra high power battery for Mercedes-Benz HighPerformanceEngines for use by the Vodafone McLaren Mercedes team that provides more than ten times the W/kg as compared to a standard Prius battery.

    Improved safety.  Our batteries are more resistant than conventional and other advanced lithium-ion batteries to failures such as fire and explosion under certain conditions, including overcharge, overheating and physical damage.

    Long cycle and calendar life.  Our batteries are designed to retain their power and energy over thousands of charging and discharging cycles and for up to ten years of overall usage time, allowing them to meet or exceed customer requirements in our target markets.

    Reduced size and weight.  Our batteries' high power and usable energy allow us to design smaller and lighter battery systems using fewer batteries to meet an application's energy needs, and our stable battery chemistry reduces the need for heavy control electronics that add to the battery systems' size and weight.

    Environmental benefits.  Unlike many other batteries, the active materials in our nanophosphate batteries do not contain nickel or manganese compounds which are classified as toxic by the U.S. Environmental Protection Agency, or the EPA, in the Toxics Release Inventory. In addition, at the end of their useful life for a particular application, it may be possible to re-purpose our batteries for other applications, which maximizes the use of raw materials and resources.

Our Competitive Strengths

        In addition to our solutions, we believe the following combination of capabilities distinguishes us from our competitors and positions us to capitalize on the expected growth in the advanced energy storage market:

    Materials science and development expertise.  Our proprietary materials formulations and coating techniques allow us to adjust the characteristics of our battery components to meet different energy and power requirements across our many applications.

    Battery design capabilities.  We offer batteries in various forms and sizes designed to deliver our technology into many different applications. Over the past 18 months, we have introduced or

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      developed several new cylindrical battery models for diverse applications as well as several new prismatic, or flat rectangular, battery models targeted at the automotive market.

    Battery systems engineering and integration expertise.  Our expertise in areas such as thermal management, power electronics, control software and battery monitoring technology allows us to customize and deliver fully-integrated systems.

    Vertical integration from battery chemistry to system design services.  Our vertical integration reduces our development time and enhances our ability to work with partners and customers because we can address design requirements at the chemistry, battery or battery system levels. Control of each design step from battery to battery system also helps us protect our intellectual property.

    Industry-leading partners in focused markets.  We work closely with leaders in each of our target markets and believe our experience with development partners provides us with a significant research and development advantage, greater access to end customers, market credibility and additional avenues to secure supply contracts.

    High-quality, volume manufacturing facilities and proprietary process technologies. We have over 450,000 square feet of manufacturing facilities in China, Korea, Michigan and Massachusetts. Our internal manufacturing operations provide us with direct control over the quality of our products and improve the protection of our materials science, systems and production process intellectual property. We are compliant with ISO 9001:2000 certification and are pursuing TS16949 certification.

Our Strategy

        Our goal is to utilize our materials science expertise, our battery and battery systems engineering expertise and our manufacturing process technologies to provide advanced battery solutions. We intend to pursue the following strategies to attain this goal:

    Pursue markets and customers where our technology creates a competitive advantage. We will continue to focus our efforts in markets where customers place a premium on high-quality batteries, innovation and differentiated performance.

    Partner with industry leaders to adapt and commercialize our products to meet the requirements of our target markets. In each of our target markets, our joint development and supply agreements with industry-leading companies provide us insight into the performance requirements of that market, allow us to share product development costs and position our products to serve as a key strategic element for our partners' success.

    Actively pursue federal and state incentive funding for battery development, facility expansion and job creation.  We intend to take advantage of U.S. government and state programs established to increase domestic investment in the battery industry.

    Expand our manufacturing capacity in the United States.  If we receive sufficient federal and state incentive funding, we plan to aggressively expand our domestic battery manufacturing capacity. Our plan involves building vertically integrated manufacturing plants in the United States that encompass the full production process, including the manufacturing of our proprietary cathode powder, electrode coating, battery fabrication and the assembly of complete battery systems ready for vehicle integration.

    Remain on the forefront of innovation and commercialization of new battery and system technologies. We believe that our nanophosphate and battery design technologies provide us with a competitive advantage, and we intend to continue to innovate in materials science and product design.

    Reduce costs through manufacturing improvements, supply chain efficiencies, innovation in materials and battery technologies. We believe that we can lower our battery and battery system costs by improving our manufacturing performance, lowering our raw material procurement costs,

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      improving our inventory and supply chain management and through further materials science and battery innovation that can help reduce our need for expensive control and electronic components.

Risks That We Face

        Our business is subject to numerous risks and uncertainties, as more fully described under "Risk Factors" beginning on page 10, which you should carefully consider prior to deciding whether to invest in our common stock. For example,

    we have had a history of losses, and we may be unable to achieve or sustain profitability. In addition, we have yet to achieve positive cash flow and our ability to generate positive cash flow is uncertain;

    if we are unable to develop, manufacture and market products that improve upon existing battery technology and gain market acceptance, our business will be adversely affected;

    because we build our manufacturing capacity based on our projection of future development and supply agreement wins, our business revenues and profits will depend upon our ability to enter into and complete these agreements, successfully complete these capacity expansion projects, achieve competitive manufacturing yields and drive volume sales consistent with our demand expectations;

    we rely on a limited number of customers for a significant portion of our revenue, and the loss of our most significant or several of our smaller customers could materially harm our business;

    we may not be able to obtain, or to agree on acceptable terms and conditions for, all or a significant portion of the government grants, loans, and other incentives for which we have applied and may in the future apply;

    we are involved in patent litigation related to the technology in our batteries, including the batteries we sell to Black & Decker, in which third parties have asserted that they own or control patents that are infringed by our products, and, if this litigation is not resolved in our favor, we may be required to pay substantial damages, and we and/or our customers, development partners and licensees may be required to stop or delay activities in the United States such as research, development, manufacturing and sales of products based on technologies covered by these patents;

    our substantial manufacturing operations in China subject us to a number of risks, including the potential inability to control our operations and relationships in China, enforce any agreements we have with Chinese partners, to find, retain or train suitable employees in China and to effectively protect our intellectual property rights in China;

    adverse business or financial conditions affecting the automotive industry may have a material adverse effect on our development and marketing partners and our battery business; and

    our principal competitors have, and any future competitors may have, greater financial and marketing resources than we do, and they may therefore develop batteries or other technologies similar or superior to ours or otherwise compete more successfully than we do.

Company Information

        We were incorporated in Delaware on October 19, 2001. Our corporate headquarters are located at Arsenal on the Charles, 321 Arsenal Street, Watertown, Massachusetts 02472, and our telephone number is (617) 778-5700. Our website address is www.a123systems.com. The information contained on our website or that can be accessed through our website is not part of this prospectus, and investors should not rely on any such information in deciding whether to purchase our common stock.

        We use various trademarks and trade names in our business, including without limitation "A123" and "A123 Systems." This prospectus also contains trademarks and trade names of other businesses that are the property of their respective holders.

        Unless the context otherwise requires, we use the terms "A123," "our company," "we," "us" and "our" in this prospectus to refer to A123 Systems, Inc. and its subsidiaries.

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THE OFFERING

Common stock offered by A123

  25,000,000 shares

Common stock offered by the selling stockholders

  680,501 shares

Over-allotment option

  3,852,075 shares

Common stock to be outstanding after this offering

  96,816,482 shares

Use of proceeds

  We intend to use the net proceeds to us from this offering for capital expenditures, working capital and other general corporate purposes. We may use a portion of the net proceeds to us to expand our current business through acquisitions of other companies, assets or technologies. We will not receive any proceeds from the sale of shares by the selling stockholders. The selling stockholders consist of our chief executive officer and all of our founders, including our chief technology officer and vice president of business development. See the "Use of Proceeds" section of this prospectus for more information.

Risk factors

  You should read the "Risk Factors" section of this prospectus beginning on page 10 for a discussion of factors to consider carefully before deciding whether to purchase shares of our common stock.

Proposed symbol

  "AONE"

        The number of shares of our common stock to be outstanding after this offering is based on 70,680,520 shares of our common stock outstanding as of August 31, 2009 and excludes:

    10,493,698 shares of our common stock issuable upon the exercise of stock options outstanding as of August 31, 2009 at a weighted average exercise price of $5.54 per share;

    3,285,324 shares of our common stock reserved as of August 31, 2009 for future issuance under our 2001 and 2009 stock incentive plans; and

    171,696 shares of our common stock issuable upon the exercise of warrants outstanding as of August 31, 2009 at a weighted average exercise price of $4.12 per share.

        Unless otherwise indicated, the information in this prospectus assumes the following:

    an initial public offering price of $10.75 per share, which is the midpoint of the range listed on the cover page of this prospectus;

    the automatic conversion of all of our outstanding convertible preferred stock, other than shares of our series E and series F convertible preferred stock, into shares of our common stock, on a one-for-one basis, upon the closing of this offering;

    the automatic conversion of all of our outstanding series E convertible preferred stock into shares of our common stock, on a one-for-1.416 basis, upon the closing of this offering;

    the automatic conversion of all of our outstanding series F convertible preferred stock into shares of our common stock, on a one-for-1.085 basis, upon the closing of this offering;

    the filing of our restated certificate of incorporation and the adoption of our restated by-laws as of the closing date of this offering; and

    no exercise by the underwriters of their over-allotment option.

        The conversion ratios at which our series E and F convertible preferred stock convert into shares of our common stock adjust based on the initial public offering price. See Note 16 to our consolidated financial statements.

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SUMMARY CONSOLIDATED FINANCIAL DATA

        You should read the following consolidated financial information together with the more detailed information contained in "Selected Consolidated Financial Data," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our consolidated financial statements and the related notes appearing elsewhere in this prospectus.

 
  Year Ended December 31,   Six Months Ended
June 30,
 
 
  2006   2007   2008   2008   2009  
 
  (in thousands, except per share data)
 

Consolidated Statement of Operations Data:

                               

Revenue

                               

Product

  $ 28,346   $ 35,504   $ 53,514   $ 18,015   $ 36,638  

Research and development services

    6,002     5,845     15,011     3,919     6,284  
                       
   

Total revenue

    34,348     41,349     68,525     21,934     42,922  
                       

Cost of revenue

                               

Product

    28,960     38,320     70,474     23,797     39,186  

Research and development services

    4,417     4,499     10,295     2,878     4,505  
                       
   

Total cost of revenue

    33,377     42,819     80,769     26,675     43,691  
                       

Gross profit (loss)

    971     (1,470 )   (12,244 )   (4,741 )   (769 )
                       

Operating expenses

                               
 

Research and development

    8,851     13,241     36,953     15,094     22,814  
 

Sales and marketing

    1,537     4,307     8,851     3,606     4,227  
 

General and administrative

    6,129     13,336     21,544     8,831     12,452  
                       
   

Total operating expenses

    16,517     30,884     67,348     27,531     39,493  
                       

Operating loss

    (15,546 )   (32,354 )   (79,592 )   (32,272 )   (40,262 )
                       

Other income (expense):

                               
 

Interest income

    871     1,729     1,258     614     62  
 

Interest expense

    (641 )   (716 )   (812 )   (407 )   (572 )
 

Gain (loss) on foreign exchange

        502     (724 )   76     (115 )
 

Unrealized loss on preferred stock warrant liability

    (362 )   (57 )   (286 )   (759 )   (70 )
                       

Other income (expense), net

    (132 )   1,458     (564 )   (476 )   (695 )
                       

Loss from operations, before tax

    (15,678 )   (30,896 )   (80,156 )   (32,748 )   (40,957 )

Provision for income taxes

    40     97     275     184     267  
                       

Loss from operations, net of tax

    (15,718 )   (30,993 )   (80,431 )   (32,932 )   (41,224 )

Cumulative effect of change in accounting principle

    (57 )                
                       
   

Net loss

    (15,775 )   (30,993 )   (80,431 )   (32,932 )   (41,224 )

Less: Net loss (income) attributable to the noncontrolling interest

        27     (39 )   (63 )   574  
                       

Net loss attributable to A123 Systems, Inc. 

    (15,775 )   (30,966 )   (80,470 )   (32,995 )   (40,650 )

Accretion to preferred stock

    (26 )   (35 )   (42 )   (20 )   (28 )
                       

Net loss attributable to A123 Systems, Inc. common stockholders

  $ (15,801 ) $ (31,001 ) $ (80,512 ) $ (33,015 ) $ (40,678 )
                       

(Footnotes appear on following page)

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  Year Ended December 31,   Six Months Ended
June 30,
 
 
  2006   2007   2008   2008   2009  
 
  (in thousands, except per share data)
 

Net loss per share attributable to common stockholders—basic and diluted:

                               
 

Loss per share attributable to common stockholders before cumulative effect of change in accounting principle

  $ (2.64 ) $ (4.88 ) $ (9.04 ) $ (3.85 ) $ (4.39 )
 

Cumulative effect of change in accounting principle

    (0.01 )                
                       
   

Net loss per share attributable to common stockholders—basic and diluted

  $ (2.65 ) $ (4.88 ) $ (9.04 ) $ (3.85 ) $ (4.39 )
                       

Weighted average number of common shares outstanding:

    5,971     6,351     8,904     8,579     9,272  
                       
 

Pro forma net loss per share—basic and diluted(1)

              $ (1.47 )       $ (0.65 )
                             
 

Pro forma weighted average common shares outstanding(1)

                54,764           62,939  
                             

 

 
  Years Ended December 31,   Six Months Ended
June 30,
 
 
  2006   2007   2008   2008   2009  
 
  (in thousands)
 

Other Operating Data:

                               

Shipments (in watt hours, or Wh)(2)

    20,016     32,010     44,900     15,423     27,663  

 

 
  As of June 30, 2009  
 
  Actual   Pro Forma(3)   Pro Forma
As Adjusted(4)
 
 
  (in thousands)
 

Consolidated Balance Sheet Data:

                   

Cash and cash equivalents

  $ 114,877   $ 114,877   $ 362,581  

Working capital

    125,807     125,807     373,783  

Total assets

    269,408     269,408     512,267  

Preferred stock warrant liability

    1,020          

Long-term debt, including current portion

    16,238     16,238     16,238  

Redeemable convertible preferred stock

    334,572          

Redeemable common stock

    11,500          

Total A123 Systems, Inc. stockholders' (deficit) equity

    (170,319 )   176,773     419,904  

(1)
The pro forma net loss per share, basic and diluted, and pro forma weighted average shares outstanding in the table above give effect to the automatic conversion of all of our outstanding convertible preferred stock and redeemable common stock into common stock upon the closing of this offering.

(2)
We measure our product shipments in watt hours, or Wh, which refers to the aggregate amount of energy that could be delivered in a single complete discharge of a battery. We calculate watt hours for each of our battery models by multiplying the battery's amp hour, or Ah, storage capacity by the battery's voltage rating. For example, our 26650 battery is a 2.3 Ah battery that operates at 3.3 V, resulting in a 7.6 Wh rating. The Wh metric allows us and our investors to measure our manufacturing capacity and shipments, regardless of battery voltages and Ah specifications, utilizing a uniform and consistent metric.

(3)
The pro forma consolidated balance sheet data in the table above give effect to the automatic conversion of all of our outstanding convertible preferred stock and redeemable common stock into common stock upon the closing of this offering.

(4)
The pro forma as adjusted consolidated balance sheet data in the table above give effect to our receipt of the estimated net proceeds to us from this offering at an assumed initial public offering price of $10.75 per share, which is the midpoint of the range listed on the cover page of this prospectus, after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us.

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RISK FACTORS

        An investment in our common stock involves a high degree of risk. You should carefully consider the risks described below before making an investment decision. Our business, prospects, financial condition or operating results could be harmed by any of these risks, as well as other risks not currently known to us or that we currently consider immaterial. The trading price of our common stock could decline due to any of these risks, and, as a result, you may lose all or part of your investment. Before deciding whether to invest in our common stock, you should also refer to the other information contained in this prospectus, including our consolidated financial statements and the related notes.

Risks Related to Our Business

We have had a history of losses, and we may be unable to achieve or sustain profitability.

        We have never been profitable. We experienced net losses of $15.8 million for 2006, $31.0 million for 2007, $80.5 million for 2008, and $40.7 million for the six months ended June 30, 2009. We expect we will continue to incur net losses in 2009. We expect to incur significant future expenses as we develop and expand our business and our manufacturing capacity. In addition, as a public company, we will incur additional significant legal, accounting and other expenses that we did not incur as a private company. These increased expenditures will make it harder for us to achieve and maintain future profitability. We may incur significant losses in the future for a number of reasons, including the other risks described in this prospectus, and we may encounter unforeseen expenses, difficulties, complications, delays and other unknown events. Accordingly, we may not be able to achieve or maintain profitability.

We have yet to achieve positive cash flow, and our ability to generate positive cash flow is uncertain.

        To rapidly develop and expand our business, we have made significant up-front investments in our manufacturing capacity and incurred research and development, sales and marketing and general and administrative expenses. In addition, our growth has required a significant investment in working capital over the last several years. We have had negative cash flow before financing activities of $29.1 million for 2006, $56.1 million for 2007, $76.0 million for 2008, and $62.2 million for the six months ended June 30, 2009. We anticipate that we will continue to have negative cash flow for the foreseeable future as we continue to make significant future capital expenditures to expand our manufacturing capacity and incur increased research and development, sales and marketing, and general and administrative expenses. Our business will also require significant amounts of working capital to support our growth. Therefore, we may need to raise additional capital from investors to achieve our expected growth, and we may not achieve sufficient revenue growth to generate positive future cash flow. An inability to generate positive cash flow for the foreseeable future or raise additional capital on reasonable terms may decrease our long-term viability.

Our limited operating history makes it difficult to evaluate our current business and future prospects.

        We have been in existence since 2001, but much of our growth has occurred in recent periods. Our limited operating history may make it difficult to evaluate our current business and our future prospects. We have encountered and will continue to encounter risks and difficulties frequently experienced by growing companies in rapidly changing industries, including increasing expenses as we continue to grow our business. If we do not manage these risks successfully, our business will be harmed.

        In addition, we are targeting new and emerging markets for our batteries and battery systems. However, historically, a significant portion of the products that we have sold are designed for the consumer tool market, which is a more mature market with different growth prospects than our other target markets. Several of our products are still under development, including a battery in prismatic form designed for use in the automotive industry, and the timing of the ultimate release, if any, of new production quality

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products is not determinable. Our efforts to expand beyond our existing markets may never result in new products that achieve market acceptance, create additional revenue or become profitable. Therefore, our recent historical growth trajectory may not provide an accurate representation of the market dynamics we may be exposed to in the future, making it difficult to evaluate our future prospects.

The demand for batteries in the transportation and other markets depends on the continuation of current trends resulting from dependence on fossil fuels. Extended periods of low gasoline prices could adversely affect demand for electric and hybrid electric vehicles.

        We believe that much of the present and projected demand for advanced batteries in the transportation and other markets results from recent increases in the cost of oil, the dependency of the United States on oil from unstable or hostile countries, government regulations and economic incentives promoting fuel efficiency and alternate forms of energy, as well as the belief that climate change results in part from the burning of fossil fuels. If the cost of oil decreased significantly, the outlook for the long-term supply of oil to the United States improved, the government eliminated or modified its regulations or economic incentives related to fuel efficiency and alternate forms of energy, or if there is a change in the perception that the burning of fossil fuels negatively impacts the environment, the demand for our batteries could be reduced, and our business and revenue may be harmed.

        Gasoline prices have been extremely volatile, and this continuing volatility is expected to persist. Lower gasoline prices over extended periods of time may lower the perception in government and the private sector that cheaper, more readily available energy alternatives should be developed and produced. If gasoline prices remain at deflated levels for extended periods of time, the demand for hybrid and electric vehicles may decrease, which would have a material adverse effect on our business.

If we are unable to develop, manufacture and market products that improve upon existing battery technology and gain market acceptance, our business may be adversely affected. In addition, many factors outside of our control may affect the demand for our batteries and battery systems.

        We are researching, developing, manufacturing and selling lithium-ion batteries and battery systems. The market for advanced rechargeable batteries is at a relatively early stage of development, and the extent to which our lithium-ion batteries will be able to meet our customers' requirements and achieve significant market acceptance is uncertain. Rapid and ongoing changes in technology and product standards could quickly render our products less competitive, or even obsolete if we fail to continue to improve the performance of our battery chemistry and systems. Other companies that are seeking to enhance traditional battery technologies have recently introduced or are developing batteries based on nickel metal-hydride, liquid lithium-ion and other emerging and potential technologies. These competitors are engaged in significant development work on these various battery systems. One or more new, higher energy rechargeable battery technologies could be introduced which could be directly competitive with, or superior to, our technology. The capabilities of many of these competing technologies have improved over the past several years. Competing technologies that outperform our batteries could be developed and successfully introduced, and as a result, there is a risk that our products may not be able to compete effectively in our target markets. If our battery technology is not adopted by our customers, or if our battery technology does not meet industry requirements for power and energy storage capacity in an efficient and safe design our batteries will not gain market acceptance.

        In addition, the market for our products depends upon third parties creating or expanding markets for their end-user products that utilize our batteries and battery systems. If such end-user products are not developed, if we are unable to have our products designed into these end user products, if the cost of these end-user products is too high, or the market for such end-user products contracts or fails to develop, the market for our batteries and battery systems would be expected similarly to contract or collapse. Our customers operate in extremely competitive industries, and competition to supply their needs focuses on

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delivering sufficient power and capacity in a cost, size and weight efficient package. The ability of our customers to adopt new battery technologies will depend on many factors outside of our control. For example, in the automotive industry, we depend on our customers' ability to develop HEV, PHEV and EV platforms that gain broad appeal among end users.

        Many other factors outside of our control may also affect the demand for our batteries and battery systems and the viability of widespread adoption of advanced battery applications, including:

    performance and reliability of battery power products compared to conventional and other non-battery energy sources and products;

    success of alternative battery chemistries, such as nickel-based batteries, lead-acid batteries and conventional lithium-ion batteries and the success of other alternative energy technologies, such as fuel cells and ultra capacitors;

    end-users' perceptions of advanced batteries as relatively safe and reliable energy storage solutions, which could change over time if alternative battery chemistries prove unsafe or become the subject of significant product liability claims and negative publicity is generated on the battery industry as a whole;

    cost-effectiveness of our products compared to products powered by conventional energy sources and alternative battery chemistries;

    availability of government subsidies and incentives to support the development of the battery power industry;

    fluctuations in economic and market conditions that affect the cost of energy stored by batteries, such as increases or decreases in the prices of electricity;

    continued investment by the federal government and our customers in the development of battery powered applications;

    heightened awareness of environmental issues and concern about global warming and climate change; and

    regulation of energy industries.

Adverse business or financial conditions affecting the automobile industry may have a material adverse effect on our development and marketing partners and our battery business.

        Much of our business depends on and is directly affected by the general economic state of the United States and global automobile industry. The effect of the continued economic difficulties of the major automobile manufacturers on our business is unclear. Two major auto manufacturers have filed for bankruptcy and one of our existing customers has entered into a debt restructuring process, and it is possible that more of these companies may encounter financial difficulties. The impact of any such financial difficulties on the automobile industry and its suppliers is unclear and difficult to predict. Possible effects could include reduced spending on alternative energy systems for automobiles, a delay in the introduction of new, or the cancellation of new and existing, hybrid and electric vehicles and programs, and a delay in the conversion of existing batteries to lithium-ion batteries, each of which would have a material adverse effect on our business.

        We have entered into agreements relating to joint design and development efforts with several automotive manufacturers and tier 1 suppliers regarding their HEV, PHEV and EV development efforts. Certain of these manufacturers and suppliers have in recent years experienced static or reduced revenues, increased costs, net losses, loss of market share, bankruptcy, labor issues and other business and financial challenges. The viability of the "Big Three" U.S. auto manufacturers, particularly GM and Chrysler,

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remains unclear. As a result, these or other automotive manufacturers may discontinue or delay their planned introduction of HEVs, PHEVs or EVs as a result of adverse changes in their financial condition or other factors. Automotive manufacturers may also seek alternative battery systems from other suppliers which may be more cost-effective or require fewer modifications in standard manufacturing processes than our products. We may also experience delays or losses with respect to the collection of payments due from customers in the automotive industry experiencing financial difficulties. For example, one of our customers, Think Global, is experiencing financial difficulties. As a result, we recorded an allowance for bad debt of $1.3 million for the outstanding amounts due from Think and recorded a $2.6 million charge for obsolete inventory related to this program.

We have experienced rapid growth in recent periods. If we fail to manage our growth effectively, we may be unable to execute our business plan, maintain high levels of service or address competitive challenges adequately.

        We increased our number of full-time employees from 227 at December 31, 2006 to 1,672 at August 31, 2009, and our revenue increased from $34.3 million in 2006 to $68.5 million in 2008. Our growth has placed, and may continue to place, a significant strain on our managerial, administrative, operational, financial, information technology and other resources. We intend to further expand our overall business, customer base, headcount and operations both domestically and internationally. Expanding a global organization and managing a geographically dispersed workforce will require substantial management effort and significant additional investment in our infrastructure. We will be required to continue to improve our operational, financial and management controls and our reporting procedures and we may not be able to do so effectively. As such, we may be unable to manage our expenses effectively in the future, which may negatively impact our operating results in any particular quarter.

Because we build our manufacturing capacity based on our projection of future design wins and supply agreements, our business revenue and profits will depend upon our ability to enter into and complete these agreements, successfully complete these expansion projects, achieve competitive manufacturing yields and drive volume sales consistent with our demand expectations.

        In order to fulfill the anticipated demand for our products, we invest in capital expenditures in advance of actual customer orders, based on estimates of future demand. We plan to continue the expansion of our manufacturing capacity across multiple product lines. The build-up of our internal manufacturing capabilities exposes us to significant up-front fixed costs. If market demand for our products does not increase as quickly as we have anticipated and align with our expanded manufacturing capacity, or if we fail to enter into and complete projected development and supply agreements, we may be unable to offset these costs and to achieve economies of scale, and our operating results may be adversely affected as a result of high operating expenses, reduced margins, underutilization of capacity and asset impairment charges. Alternatively, if we experience demand for our products in excess of our estimates, our installed capital equipment may be insufficient to support higher production volumes, which could harm our customer relationships and overall reputation. In addition, we may not be able to expand our workforce and operations in a timely manner, procure adequate resources, or locate suitable third-party suppliers, to respond effectively to changes in demand for our existing products or to the demand for new products requested by our customers, and our current or future business could be materially and adversely affected. Our ability to meet such excess customer demand could also depend on our ability to raise additional capital and effectively scale our manufacturing operations.

        We utilize standard manufacturing equipment that we modify and customize in order to meet our production needs. While this equipment may be available from various suppliers, its procurement requires long lead times. Therefore, we may experience delays, additional or unexpected costs and other adverse events in connection with our capacity expansion projects, including those associated with potential delays in the procurement and customization of manufacturing equipment.

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        If we are unable to achieve and maintain satisfactory production yields and quality as we expand our manufacturing capabilities, our relationships with certain customers and overall reputation may be harmed, and our sales could decrease.

We may not be able to obtain, or to agree on acceptable terms and conditions for, all or a significant portion of the government grants, loans and other incentives for which we have applied and may in the future apply. Our customers and potential customers applying for government grants, loans and other incentives may condition purchases of our products upon their receipt of these funds or delay purchases of our products until their receipt of these funds.

        We have applied for federal and state grants, loans and tax incentives under government programs designed to stimulate the economy and support the production of electric vehicles and advanced battery technologies. Much of our planned domestic manufacturing capacity expansion depends on receipt of these funds and other incentives, and the failure to obtain these funds or other incentives could materially and adversely affect our ability to expand our manufacturing capacity and meet planned production levels. We anticipate that in the future there will be new opportunities for us to apply for grants, loans and other incentives from the United States, state and foreign governments. Our ability to obtain funds or incentives from government sources is subject to the availability of funds under applicable government programs and approval of our applications to participate in such programs. The application process for these funds and other incentives is and will be highly competitive. While we have been notified that we have been selected to receive a grant under the DOE Battery Initiative and have received some state incentives, we cannot assure you that we will be successful in obtaining additional grants, loans and other incentives. Moreover, state incentives depend on the continued availability of state funds. With respect to the grant which we have been awarded and the grants, loans and other incentives we may be awarded, we may not be able to satisfy or continue to satisfy the requirements and milestones imposed by the granting authority as conditions to receipt of the funds or other incentives, the timing of the receipt of the funds may not meet our needs and we nevertheless may be unable to successfully execute on our business plan. Moreover, not all of the terms and conditions associated with these incentive funds have been disclosed to us, and once disclosed, there may be terms and conditions with which we are unable to comply or which are commercially unacceptable to us. In addition, the DOE Battery initiative grant and any other federal government programs which may make additional awards to us will require us to spend a portion of our own funds for every incentive dollar we receive or are permitted to borrow from the government and will impose time limits during which we must use the funds awarded to us. If we are unable to raise sufficient additional capital so that we are able to receive all of the amounts which have and may be awarded to us in a timely manner, our ability to expand our manufacturing capacity could be materially adversely affected. In addition, less than expected actual and anticipated future demand for our products may cause us to slow the pace of the expansion of our manufacturing capacity such that we are not able to use the government incentive funds awarded or made available to us in the time periods required by the granting authorities.

        Our customers and potential customers applying for these government grants, loans and other incentives may condition purchases of our products upon receipt of these funds or delay purchases of our products until receipt of these funds, and if our customers and potential customers do not receive these funds or the receipt of these funds is significantly delayed, our results of operations could suffer.

We rely on a limited number of customers for a significant portion of our revenue, and the loss of our most significant or several of our smaller customers could materially harm our business.

        A significant portion of our revenue is generated from a limited number of customers. During each of the years ended December 31, 2007 and 2008 and the six months ended June 30, 2008 and 2009, Black & Decker, together with its affiliates, represented 66%, 44%, 49% and 19% of our revenue, respectively. During the year ended December 31, 2008 and the six months ended June 30, 2009, revenue from Mercedes-Benz HighPerformanceEngines represented 12% and 16%, respectively, of our revenue. We

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expect revenue from Black & Decker will decline in the remainder of 2009 and therefore represent a smaller percentage of our revenue in future quarters. In addition, we do not anticipate receiving any more revenue in 2009 from Mercedes-Benz HighPerformanceEngines. For the six months ended June 30, 2009, revenue from BAE Systems represented 37% of our revenue. Although the composition of our significant customers will vary from period to period, we expect that most of our revenue will continue, for the forseeable future, to come from a relatively small number of customers. In addition, our contracts with our customers do not include long-term commitments or minimum volumes that ensure future sales of our products. Consequently, our financial results may fluctuate significantly from period-to-period based on the actions of one or more significant customers. A customer may take actions that affect us for reasons that we cannot anticipate or control, such as reasons related to the customer's financial condition, changes in the customer's business strategy or operations, the introduction of alternative competing products, or as the result of the perceived quality or cost-effectiveness of our products. Our agreements with these customers may be cancelled if we fail to meet certain product specifications or materially breach the agreement or for other reasons outside of our control. In addition, our customers may seek to renegotiate the terms of current agreements or renewals. The loss of or a reduction in sales or anticipated sales to our most significant or several of our smaller customers could have a material adverse effect on our business, financial condition and results of operations.

Our financial results may vary significantly from period-to-period due to the long and unpredictable sales cycles for some of our products, the seasonality of certain end markets into which we sell our products, and changes in the mix of products we sell during a period, which may lead to volatility in our stock price.

        The size and timing of our revenue from sales to our customers is difficult to predict and is market dependent. Our sales efforts often require us to educate our customers about the use and benefits of our products, including their technical and performance characteristics. Customers typically undertake a significant evaluation process that has in the past resulted in a lengthy sales cycle for us, typically many months. In some markets such as the transportation market, there is usually a significant lag time between the design phase and commercial production. We spend substantial amounts of time and money on our sales efforts and there is no assurance that these investments will produce any sales within expected time frames or at all. Given the potentially large size of battery development and supply contracts, the loss of or delay in the signing of a contract or a customer order could reduce significantly our revenue in any period. Since most of our operating and capital expenses are incurred based on the estimated number of design wins and their timing, they are difficult to adjust in the short term. As a result, if our revenue falls below our expectations or is delayed in any period, we may not be able to reduce proportionately our operating expenses or manufacturing costs for that period, and any reduction of manufacturing capacity could have long-term implications on our ability to accommodate future demand.

        Our profitability from period-to-period may also vary significantly due to the mix of products that we sell in different periods. While we have sold most of our products to date into the consumer market, as we expand our business we expect to sell new battery and battery system products into other markets and for other applications. These products are likely to have different cost profiles and will be sold into markets governed by different business dynamics. Consequently, sales of individual products may not necessarily be consistent across periods, which could affect product mix and cause gross and operating profits to vary significantly.

        In addition, since our batteries and battery systems are incorporated into our customers' products for sale into their respective end markets, our business is exposed to the seasonal demand that may characterize some of our customers' own product sales. Because many of our expenses are based on anticipated levels of annual revenue, our business and operating results could also suffer if we do not achieve revenue consistent with our expectations for this seasonal demand.

        As a result of these factors, we believe that quarter-to-quarter comparisons of our operating results are not necessarily meaningful and that these comparisons cannot be relied upon as indicators of future

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performance. Moreover, our operating results may not meet expectations of equity research analysts or investors. If this occurs, the trading price of our common stock could fall substantially either suddenly or over time.

Our principal competitors have, and any future competitors may have, greater financial and marketing resources than we do, and they may therefore develop batteries or other technologies similar or superior to ours or otherwise compete more successfully than we do.

        Competition in the battery industry is intense. The industry consists of major domestic and international companies, most of which have existing relationships in the markets into which we sell as well as financial, technical, marketing, sales, manufacturing, scaling capacity, distribution and other resources and name recognition substantially greater than ours. These companies may develop batteries or other technologies that perform as well as or better than our batteries. We believe that our primary competitors are existing suppliers of cylindrical lithium-ion, nickel cadmium, nickel metal-hydride and in some cases, non-starting/lighting/ignition lead-acid batteries. A number of our competitors have existing and evolving relationships with our target customers. For example, Bosch and Samsung formed LiMotive to focus on the development, production and marketing of lithium-ion battery systems for application in hybrid and other electric vehicles, and Dow Chemical recently announced the establishment of a joint venture with Kokam America and others, pending receipt of government incentive funding, to build a facility in Michigan for the manufacture of lithium polymer batteries for use in HEVs and EVs. In addition, NEC and Nissan entered into a joint venture to develop lithium-ion batteries in prismatic form, Sanyo and Volkswagen agreed to develop lithium-ion batteries for HEVs, Sanyo already provides nickel metal hydride batteries for Ford and Honda, and Toyota and Panasonic are engaged in a joint venture to make batteries for HEVs and EVs. In addition, we expect new competitors will enter the markets for our products in the future. Potential customers may choose to do business with our more established competitors, because of their perception that our competitors are more stable, are more likely to complete various projects, can scale operations more quickly, have greater manufacturing capacity, are more likely to continue as a going concern and lend greater credibility to any joint venture. If we are unable to compete successfully against manufacturers of other batteries or technologies in any of our targeted applications, our business could suffer, and we could lose or be unable to gain market share.

If our products fail to perform as expected, we could lose existing and future business, and our ability to develop, market and sell our batteries and battery systems could be harmed.

        Our products are complex and could have unknown defects or errors, which may give rise to claims against us, diminish our brand or divert our resources from other purposes. Despite testing, new and existing products have contained defects and errors and may in the future contain manufacturing or design defects, errors or performance problems when first introduced, when new versions or enhancements are released, or even after these products have been used by our customers for a period of time. These problems could result in expensive and time-consuming design modifications or warranty charges, delays in the introduction of new products or enhancements, significant increases in our service and maintenance costs, exposure to liability for damages, damaged customer relationships and harm to our reputation, any of which may adversely affect our business and our operating results.

        Our success in the transportation market depends, in part, on our ability to design, develop and commercially manufacture lithium-ion batteries in prismatic form for use in HEVs, PHEVs and EVs currently being developed and that may be developed in the future. The design and development of a lithium-ion battery in prismatic form for use in the automotive industry is complex, expensive, time-consuming and subject to rigorous quality and performance requirements. If we are unable to design, develop and commercially manufacture lithium-ion batteries in prismatic form that are accepted for use in the automotive industry, our business and operating results may be adversely affected.

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We have identified material weaknesses in our internal control over financial reporting and if we fail to remediate these weaknesses and maintain proper and effective internal controls, our ability to produce accurate and timely financial statements could be impaired, which could harm our operating results, our ability to operate our business and investors' views of us.

        Ensuring that we have adequate internal financial and accounting controls and procedures in place so that we can produce accurate financial statements on a timely basis is a costly and time-consuming effort that needs to be evaluated frequently. In connection with our financial audits, we identified material weaknesses in our internal control over financial reporting. A material weakness is defined as a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company's annual or interim financial statements will not be prevented or detected on a timely basis by the company's internal controls. These material weaknesses were as follows:

    we did not have an adequate number of personnel in our accounting and finance department with sufficient technical accounting expertise and, as a result, we could not evaluate in a timely manner the accounting implications of our business transactions; and

    we did not design or maintain effective operating and information technology controls over the financial statement close and reporting process in order to ensure the accurate and timely preparation of financial statements in accordance with accounting principles generally accepted in the United States, or GAAP.

        We are in the process of taking the necessary steps to remediate the material weaknesses that we identified and have made enhancements to our control procedures; however, the material weaknesses will not be remediated until the necessary controls have been implemented and are operating effectively. We do not know the specific time frame needed to fully remediate the material weaknesses identified.

        We cannot assure you that our efforts to fully remediate these internal control weaknesses will be successful or that similar material weaknesses will not recur.

        Implementing any appropriate changes to our internal controls may distract our officers and employees, entail substantial costs to implement new processes and modify our existing processes and take significant time to complete. Moreover, these changes do not guarantee that we will be effective in maintaining the adequacy of our internal controls, and any failure to maintain that adequacy, or consequent inability to produce accurate financial statements on a timely basis, could increase our operating costs and harm our business. In addition, investors' perceptions that our internal controls are inadequate or that we are unable to produce accurate financial statements on a timely basis may harm our stock price and make it more difficult for us to effectively market and sell our products to new and existing customers. For a more detailed discussion of our material weaknesses, see "Management's Discussion and Analysis of Financial Condition and Results of Operations—Internal Control Over Financial Reporting."

If our warranty expense estimates differ materially from our actual claims, or if we are unable to estimate future warranty expense for new products, our business and financial results could be harmed.

        Our warranty for our products ranges from one to five years from the date of sale, depending on the type of product and its application. We expect that in the future some of our warranties will extend beyond five years. In the consumer market, we typically provide a warranty against certain potential manufacturing defects, which may cause high-rates of self-discharge, inaccurate voltage, and other product irregularities. In the electric grid services and transportation markets, we may also provide a warranty against a certain percentage decline in the initial power and energy density specifications of a particular product. Since we began selling our first products in the consumer market in the first quarter of 2006 and in the transportation market in the first quarter of 2007, and we have only recently shipped our first product in the electric grid services market, we have a limited product history on which to base our warranty

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estimates. Because of the limited operating history of our batteries and battery systems, our management is required to make assumptions and to apply judgment regarding a number of factors, including anticipated rate of warranty claims, the durability and reliability of our products, and service delivery costs. Our assumptions could prove to be materially different from the actual performance of our batteries and battery systems, which could cause us to incur substantial expense to repair or replace defective products in the future and may exceed expected levels against which we have reserved. If our estimates prove incorrect, we could be required to accrue additional expenses from the time we realize our estimates are incorrect and also face a significant unplanned cash burden at the time our customers make a warranty claim, which could harm our operating results.

        In addition, with our new products and products that remain under development, we will be required to base our warranty estimates on historical experience of similar products testing of our batteries and performance information learned during our development activities with the customer. If we are unable to estimate future warranty costs for any new product, we will be required to defer recognizing revenue for that product until we are able reasonably to estimate the associated warranty expense. As a result, our financial results could vary significantly from period-to-period.

Product liability or other claims could cause us to incur losses or damage our reputation.

        The risk of product liability claims and associated adverse publicity is inherent in the development, manufacturing, marketing and sale of batteries and battery systems. Certain materials we use in our batteries, as well as our batteries and battery systems, could, if used improperly, cause injuries to others. Improperly charging or discharging our batteries could cause fires. Any accident involving our batteries or other products could decrease or even eliminate demand for our products. Because some of our batteries are designed to be used in vehicles, and because vehicle accidents can cause injury to persons and damage to property, we are subject to a risk of claims for such injuries and damages. In addition, we could be harmed by adverse publicity resulting from problems or accidents caused by third party products that incorporate our batteries. For example, our business and operating results could be harmed by adverse publicity resulting from injury to persons or damage to property caused by a defective electronic system on a battery system manufactured by a third party that incorporates our batteries.

        Although we have product liability insurance for our products of up to an annual aggregate limit of $102 million, this may be inadequate to cover all potential product liability claims. In addition, while we often seek to limit our product liability in our contracts, such limits may not be enforceable or may be subject to exceptions. Any product recall or lawsuit seeking significant monetary damages either in excess of our coverage, or outside of our coverage, may have a material adverse affect on our business and financial condition. We may not be able to secure additional product liability insurance coverage on acceptable terms or at reasonable costs when needed. If we were to experience a large insured loss, it might exceed our coverage limits, or our insurance carriers could decline to further cover us or raise our insurance rates to unacceptable levels, any of which could impair our financial position and results of operations. A successful product liability claim against us could require us to pay a substantial monetary award. We cannot assure you that such claims will not be made in the future.

We are subject to financial and reputational risks due to product recalls resulting from product quality and liability issues.

        The risk of product recalls, and associated adverse publicity, is inherent in the development, manufacturing, marketing, and sale of batteries and battery systems. Our products and the products of third parties in which our products are a component are becoming increasingly sophisticated and complicated as rapid advancements in technologies occur, and as demand increases for lighter and more powerful rechargeable batteries. At the same time, product quality and liability issues present significant risks. Product quality and liability issues may affect not only our own products but also the third-party

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products in which our batteries and battery systems are a component. Our efforts and the efforts of our development partners to maintain product quality may not be successful, and if they are not, we may incur expenses in connection with, for example, product recalls and lawsuits, and our brand image and reputation as a producer of high-quality products may suffer. Any product recall or lawsuit seeking significant monetary damages could have a material adverse effect on our business and financial condition. A product recall could generate substantial negative publicity about our products and business, interfere with our manufacturing plans and product delivery obligations as we seek to replace or repair affected products, and inhibit or prevent commercialization of other future product candidates. Although we do have product liability insurance, we do not have insurance to cover the costs associated with a product recall and the expenses we would incur in connection with a product recall could have a material adverse affect on our operating results.

We depend on third parties to deliver raw materials, parts, components and services in adequate quality and quantity in a timely manner and at a reasonable price.

        Our manufacturing operations depend on obtaining raw materials, parts and components, manufacturing equipment and other supplies including services from reliable suppliers in adequate quality and quantity in a timely manner. It may be difficult for us to substitute one supplier for another, increase the number of suppliers or change one component for another in a timely manner or at all due to the interruption of supply or increased industry demand. This may adversely affect our operations. The prices of raw materials, parts and components and manufacturing equipment may increase due to changes in supply and demand. In addition, currency fluctuations and a weakening of the U.S. dollar against foreign currencies may adversely affect our purchasing power for raw materials, parts and components and manufacturing equipment from foreign suppliers.

        We depend on sole source suppliers or a limited number of suppliers for certain key raw materials and component parts used in manufacturing and developing our products. We generally purchase raw materials pursuant to purchase orders placed from time to time and have no long-term contracts or other guaranteed supply arrangements with our sole or limited source suppliers. Therefore, our operating margins may be impacted by price fluctuations in the commodities we use as raw materials in our batteries. As a result, our suppliers may not be able to meet our requirements relative to specifications and volumes for key raw materials, and we may not be able to locate alternative sources of supply at an acceptable cost. In the past, we have experienced delays in product development due to the delivery of raw materials from our suppliers that do not meet our specifications. In addition, if a sole source supplier ceased to continue to produce a component with little or no notice to us, our business could be harmed. Any future inability to obtain high quality raw materials or manufacturing equipment in sufficient quantities on competitive pricing terms and on a timely basis, due to global supply and demand or a dispute with a supplier, may delay battery production, impede our ability to fulfill existing or future purchase orders and harm our reputation and profitability.

Our failure to raise additional capital necessary to expand our operations and invest in our products and manufacturing facilities could reduce our ability to compete successfully.

        We may require additional capital in the future and we may not be able to obtain additional debt or equity financing on favorable terms, if at all. If we raise additional equity financing, our stockholders may experience significant dilution of their ownership interests, and the per share value of our common stock could decline. If we engage in debt financing, we may be required to accept terms that restrict our ability to incur additional indebtedness and force us to maintain specified liquidity or other ratios. We are also seeking federal and state grants, loans and tax incentives some of which we intend to use to expand our

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operations. We may not be successful in obtaining these funds or incentives. If we need additional capital and cannot raise or otherwise obtain it on acceptable terms, we may not be able to, among other things:

    develop or enhance our products or introduce new products;

    continue to expand our development, sales and marketing and general and administrative organizations and manufacturing operations;

    attract top-tier companies as customers or as our technology and product development partners;

    acquire complementary technologies, products or businesses;

    expand our operations, in the United States or internationally;

    expand and maintain our manufacturing capacity;

    hire, train and retain employees; or

    respond to competitive pressures or unanticipated working capital requirements.

Our working capital requirements involve estimates based on demand expectations and may decrease or increase beyond those currently anticipated, which could harm our operating results and financial condition.

        In order to fulfill the product delivery requirements of our customers, we plan for working capital needs in advance of customer orders. As a result, we base our funding and inventory decisions on estimates of future demand. If demand for our products does not increase as quickly as we have estimated or drops off sharply, our inventory and expenses could rise, and our business and operating results could suffer. Alternatively, if we experience sales in excess of our estimates, our working capital needs may be higher than those currently anticipated. Our ability to meet this excess customer demand depends on our ability to arrange for additional financing for any ongoing working capital shortages, since it is likely that cash flow from sales will lag behind these investment requirements.

Credit market volatility and illiquidity may affect our ability to raise capital to finance our operations, plant expansion and growth.

        The credit markets have experienced extreme volatility during the last year, and worldwide credit markets have remained illiquid despite injections of capital by the federal government and foreign governments. Despite the capital injections and government actions, banks and other lenders, such as equipment leasing companies, have significantly increased credit requirements and reduced the amounts available to borrowers. Companies with low credit ratings may not have access to the debt markets until the liquidity improves, if at all. If current credit market conditions do not improve, we may not be able to access debt or leasing markets to finance our plant expansion plans.

We may be unable to successfully implement or manage our planned expansion of our domestic manufacturing capability or realize the expected benefits of our planned expansion.

        We expect to aggressively expand our battery manufacturing capacity in the United States to meet expected demand for our product. Much of our planned domestic expansion depends upon our receipt of sufficient federal and state incentive funding. We may not receive the federal and state funding necessary for our planned expansion at all or on a timely basis. In addition, such funding could be subject to conditions that are commercially unacceptable to us or for which we are unable to comply. Even if we succeed in aggressively expanding our domestic manufacturing capacity, we may not have enough demand for our products to justify the increased capacity.

        Any such expansion will place a significant strain on our senior management team and our financial and other resources. Our proposed expansion will expose us to greater overhead and support costs and

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other risks associated with the manufacture and commercialization of new products. Our ability to manage our growth effectively will require us to continue to improve our operations and our financial and management information systems and to train, motivate and manage our employees. Difficulties in effectively managing the budgeting, forecasting and other process control issues presented by such a rapid expansion could harm our business, prospects, results of operations and financial condition.

We may not be able to successfully recruit and retain skilled employees, particularly scientific, technical and management professionals.

        We believe that our future success will depend in large part on our ability to attract and retain highly skilled technical, managerial and marketing personnel who are familiar with our key customers and experienced in the battery industry. We plan to continue to expand our work force both domestically and internationally. Industry demand for such employees, especially employees with experience in battery chemistry and battery manufacturing processes, however, exceeds the number of personnel available, and the competition for attracting and retaining these employees is intense. This competition will intensify if the advanced battery market continues to grow, possibly requiring increases in compensation for current employees over time. We compete in the market for personnel against numerous companies, including larger, more established competitors who have significantly greater financial resources than we do and may be in a better financial position to offer higher compensation packages to attract and retain human capital. We cannot be certain that we will be successful in attracting and retaining the skilled personnel necessary to operate our business effectively in the future. Because of the highly technical nature of our batteries and battery systems, the loss of any significant number of our existing engineering and project management personnel could have a material adverse effect on our business and operating results.

Our future success depends on our ability to retain key personnel.

        Our success will depend to a significant extent on the continued services of our senior management team, and in particular David Vieau, our chief executive officer, and Gilbert N. Riley, Jr., our chief technical officer. The loss or unavailability of either of these individuals could harm our ability to execute our business plan, maintain important business relationships and complete certain product development initiatives, which could harm our business. We do not have agreements requiring any of our senior management team to remain with our company. In addition, each of these individuals could terminate his or her relationship with us at any time, and we may be unable to enforce any applicable employment or non-compete agreements.

If we do not continue to form and maintain economic arrangements with original equipment manufacturers, or OEMs, to commercialize our products, our profitability could be impaired.

        Our business strategy requires us to integrate the design of our products into products being developed by OEMs, and therefore to identify acceptable OEMs and enter into agreements with them. In addition, we will need to meet their requirements and specifications by developing and introducing new products and enhanced or modified versions of our existing products on a timely basis. OEMs often require unique configurations or custom designs for batteries or battery systems which must be developed and integrated into a product well before the product is launched. This development process requires not only substantial lead time between the commencement of design efforts for a customized battery system and the commencement of volume shipments of the battery systems to the customer, but also the cooperation and assistance of the OEMs in order to determine the requirements for each specific application. Technical problems may arise that affect the acceptance of our product by OEMs. If we are unable to design and develop products that meet OEMs' requirements, we may lose opportunities to obtain purchase orders, and our reputation may be damaged. In addition, we may not receive adequate assistance from OEMs to successfully commercialize our products, which could impair our profitability.

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Declines in product prices may adversely affect our financial results.

        Our business is subject to intense price competition worldwide, which makes it difficult for us to maintain product prices and achieve adequate profits. Such intense price competition may adversely affect our ability to achieve profitability, especially during periods of decreases in demand. In addition, because of their purchasing size, our larger automotive customers can influence market participants to compete on price terms. If we are not able to offset pricing reductions resulting from these pressures by improved operating efficiencies and reduced expenditures, those pricing reductions may have an adverse impact on our business.

We are currently implementing a new software platform. If these implementations are not successful, our business and operations could be disrupted and our operating results could be harmed.

        We are currently implementing new software platforms to assist us in the management of our business. The implementation of new software management platforms and the addition of these platforms at new locations, especially overseas, require significant management time, support and cost. We expect the implementation and enhancements of these platforms to continue across new and existing sites worldwide. In addition, as our business continues to develop, we expect to add and enhance existing management platforms in the areas of financial, inventory control, engineering, and customer support and warranty management. We cannot be sure that these platforms will be fully or effectively implemented on a timely basis, if at all. If we do not successfully implement this project, our operations may be disrupted and our operating expenses could be harmed. In addition, the new systems may not operate as we expect them to, and we may be required to expend significant resources to correct problems or find alternative sources for performing these functions.

Our inability to effectively and quickly transfer, replicate and scale our new product manufacturing processes from low volume prototype production to high volume manufacturing facilities, could adversely affect our results of operations.

        Under our manufacturing model, we develop and establish manufacturing processes and systems for the low volume prototype production of our new products. As demand increases for a product, we transfer these processes and systems to, and replicate and scale these processes and systems in our high volume manufacturing facilities. If we are unable to effectively and quickly transfer, replicate and scale these manufacturing processes and systems, we may be unable to meet our customers' product quality and quantity requirements and lower our costs of goods sold and our results of operations could be adversely affected.

        In addition, our costs of goods sold for some of our new products exceed the purchase price for that product paid to us by our customers. If we are unable to decrease unit production costs for these products by increasing volumes, improving the manufacturing process, reducing transportation and handling costs or obtaining lower cost raw materials or component parts, we will not realize a profit from these products and our business will be harmed.

Problems in our manufacturing and assembly processes could limit our ability to produce sufficient batteries to meet the demands of our customers.

        Regardless of the process technology used, the manufacturing and assembly of safe, high-power batteries and battery systems is a highly complex process that requires extreme precision and quality control throughout a number of production stages. Because we outsource the manufacturing and assembly of one battery model and certain battery systems, we are unable to directly control delivery schedules, quality assurance, manufacturing yields and production costs. Any defects in battery packaging, impurities in the electrode materials used, contamination of the manufacturing environment, incorrect welding,

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excess moisture, equipment failure or other difficulties in the manufacturing process could cause batteries to be rejected, thereby reducing yields and affecting our ability to meet customer expectations.

        As we have scaled up our production capacity, we have experienced production problems that limited our ability to produce a sufficient number of batteries to meet the demands of one of our customers in the consumer market. If these or other production problems recur and we are unable to resolve them in a timely fashion, our business could suffer and our reputation may be harmed.

Our failure to cost-effectively manufacture our batteries and battery systems in quantities which satisfy our customers' demand and product specifications and their expectations for product quality and reliable delivery could damage our customer relationships and result in significant lost business opportunities for us.

        We manufacture a substantial percentage of our products rather than relying upon third-party outsourcing. To be successful, we must cost-effectively manufacture commercial quantities of our complex batteries and battery systems that meet our customer specifications for quality and timely delivery. To facilitate the commercialization of our products, we will need to further reduce our manufacturing costs, which we intend to do by working with manufacturing partners and by improving our manufacturing and development operations in our wholly-owned operations in China. We manufacture our batteries and assemble our products in China, Korea, Massachusetts and Michigan. We depend on the performance of our manufacturing partners, as well as our own manufacturing operations, to manufacture and deliver our products to our customers. If we or any of our manufacturing partners are unable to manufacture products in commercial quantities on a timely and cost-effective basis, we could lose our customers and be unable to attract future customers.

        In addition, we have recently begun to shift most of our battery assembly and all of our battery system manufacturing from contract manufacturing to in-house manufacturing, so our in-house experience with battery assembly and battery system manufacturing is limited.

We may be unable to complete or integrate acquisitions effectively, which may adversely affect our growth, profitability and results of operations.

        Acquisitions of businesses and assets have played a role in our growth. In the past four years, we have completed three acquisitions. However, we cannot be certain that we will be able to continue to identify attractive acquisition targets, obtain financing for acquisitions on satisfactory terms or successfully acquire identified targets. Additionally, we may not be successful in integrating acquired businesses into our existing operations and achieving projected synergies. Competition for acquisition opportunities in the various industries in which we operate may rise, thereby increasing our costs of making acquisitions or causing us to refrain from making further acquisitions. These and other acquisition-related factors could negatively and adversely impact our growth, profitability and results of operations.

Laws regulating the manufacture or transportation of batteries may be enacted which could result in a delay in the production of our batteries or the imposition of additional costs that could harm our ability to be profitable.

        Laws and regulations exist today, and additional laws and regulations may be enacted in the future, which impose environmental, health and safety controls on the storage, use and disposal of certain chemicals and metals used in the manufacture of lithium-ion batteries. Complying with any laws or regulations could require significant time and resources from our technical staff and possible redesign of one or more of our products, which may result in substantial expenditures and delays in the production of one or more of our products, all of which could harm our business and reduce our future profitability. The transportation of lithium and lithium-ion batteries is regulated both domestically and internationally. Compliance with these regulations, when applicable, increases the cost of producing and delivering our products.

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We depend on contracts with the U.S. government and its agencies or on subcontracts with the U.S. government's prime contractors for revenue and research grants to fund or partially fund our research and development programs, and our failure to retain current or obtain additional contracts could preclude us from achieving our anticipated levels of revenue growth and profitability, increase our research and development expenses and delay or halt certain research and development programs.

        Our ability to develop and market some of our products depends upon maintaining our U.S. government contract revenue and research grants obtained, which are recorded as incremental revenue and an offset to our research and development expenses, respectively. Many of our U.S. government contracts are funded incrementally, with funding decisions made on an annual basis. Approximately 2.8% of our total revenue and 26.3% of our research and development expenses during the year ended December 31, 2008 were derived from government contracts and subcontracts. Changes in government policies, priorities or programs that result in budget reductions could cause the government to cancel existing contracts or eliminate follow-on phases in the future which would severely inhibit our ability to successfully complete the development and commercialization of some of our products. In addition, there can be no assurance that, once a government contract is completed, it will lead to follow-on contracts for additional research and development, prototype build and test or production. Furthermore, there can be no assurance that our U.S. government contracts or subcontracts will not be terminated or suspended in the future. A reduction or cancellation of these contracts, or of our participation in these programs, would increase our research and development expenses, which could materially and adversely affect our results of operations and could delay or impair our ability to develop new technologies and products.

If we are unable to develop manufacturing facilities for our products in the United States, we may lose business opportunities and our customer relationships may suffer.

        We believe that developing manufacturing facilities for our products in the United States is important, in order to address national economic imperatives, such as job creation, as well as to more efficiently address the needs of our U.S.-based customers. This expansion depends upon our receiving federal and state financial incentives, primarily in the form of direct grants and loans, to provide the necessary capital for facilities and equipment. If we are unable to obtain this government assistance on a timely basis and in the amounts requested, we will not be able to scale our capacity meet current and future customer demand for our products.

Because of the funding we receive from U.S. government entities and our government business initiatives, we are subject to U.S. federal government audits and other regulation, and our failure to satisfy audit requirements or comply with applicable regulations could subject us to material adjustments or penalties that could negatively impact our business.

        The accuracy and appropriateness of our direct and indirect costs and expenses under our contracts with the U.S. government are subject to extensive regulation and audit by appropriate agencies of the U.S. government. These agencies have the right to challenge our cost estimates or allocations with respect to any such contract. Additionally, substantial portions of the payments to us under U.S. government contracts are provisional payments that are subject to potential adjustment upon audit by such agencies. Adjustments that result from inquiries or audits of our contracts could have a material adverse impact on our financial condition or results of operations. Since our inception, we have not experienced any material adjustments as a result of any inquiries or audits, but there can be no assurance that our contracts will not be subject to material adjustments in the future.

        As we grow our government business, we may also need to comply with U.S. laws regulating the export of our products, particularly in our government business. We cannot be certain of our ability to obtain any licenses required to export our products or to receive authorization from the U.S. federal government for international sales or domestic sales to foreign persons. Moreover, the export regimes and the governing policies applicable to our business are subject to change. Our failure to comply with these

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and other applicable regulations, rules and approvals could result in the imposition of penalties, the loss of our government contracts or our suspension or debarment from contracting with the federal government generally, any of which would harm our business, financial condition and results of operations.

Our ability to sell our products to our direct, OEM and tier 1 supplier customers depends in part on the quality of our engineering and customization capabilities, and our failure to offer high quality engineering support and services could have a material adverse effect on our sales and operating results.

        A high level of support is critical for the successful marketing and sale of our products. The sale of our batteries and battery systems is characterized by significant co-development and customization work in certain applications. This development process requires not only substantial lead time between the commencement of design efforts for a customized battery system and the commencement of volume shipments of the battery systems to the customer, but also the cooperation and assistance of the OEMs to determine the requirements for each specific application. Once our products are designed into an OEM or tier 1 supplier customer's products or systems, the OEM or tier 1 supplier customer depends on us to resolve issues relating to our products. If we do not effectively assist our OEM or tier 1 supplier customers in customizing, integrating and deploying our products in their own systems or products, or if we do not succeed in helping them quickly resolve post-deployment issues and provide effective ongoing technical support, our ability to sell our products would be adversely affected.

        In addition, while we have supply and co-development agreements with customers located in different regions of the world, we do not have a globally distributed engineering support and services organization. Currently, any issue resolution related to our products, system deployment or integration is channeled back to our energy solutions group in Hopkinton, Massachusetts and Novi, Michigan, from which engineers and support personnel are deployed. As we grow our business with our existing customers and beyond the markets into which we currently sell our battery technologies, we may need to increase the size of our engineering support teams and deploy them closer to our customers. Our inability to deliver a consistent level of engineering support and overall service as we expand our operations could have a material adverse effect on our business and operating results. Moreover, despite our internal quality testing, our products may contain manufacturing or design defects or exhibit performance problems at any stage of their lifecycle. These problems could result in expensive and time-consuming design modifications and impose additional needs for engineering support and maintenance services as well as significant warranty charges.

Our past and future operations may lead to substantial environmental liability.

        The handling and use of some of the materials used in the development and manufacture of our products are subject to federal, state and local environmental laws, as well as environmental laws in other jurisdictions in which we operate. Under applicable environmental laws, we may be jointly and severally liable with prior property owners for the treatment, cleanup, remediation and/or removal of any hazardous substances discovered at any property we use. In addition, courts or government agencies may impose liability for, among other things, the improper release, discharge, storage, use, disposal or transportation of hazardous substances. If we incur any significant environmental liabilities, our ability to execute our business plan and our financial condition would be harmed.

Our facilities or operations could be damaged or adversely affected as a result of disasters or unpredictable events, including widespread public health problems.

        Our headquarters, including sales offices and research and development centers, is located in Massachusetts. We also operate manufacturing, logistics, sales and research and development facilities in Michigan, China, Korea and Canada. If major disasters such as earthquakes, fires, floods, hurricanes, wars, terrorist attacks, computer viruses, pandemics or other events occur, or our information system or communications network breaks down or operates improperly, our facilities may be seriously damaged, or

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we may have to stop or delay production and shipment of our products. We may incur expenses relating to such damages. In addition, a renewed outbreak of SARS, avian flu, swine flu or another widespread public health problem in China or the United States could have a negative effect on our operations.

Risks Related to Intellectual Property

Third parties have asserted that they own or control patents that are infringed by our products.

        We are presently involved in two related patent litigations with Hydro-Québec involving certain patents it has licensed from The University of Texas, or UT, related to electrode materials used in lithium-ion batteries. After discussions with Hydro-Québec about the relevance of two of these patents to our products, we brought an action in the Federal District Court of Massachusetts seeking a declaratory judgment that our products do not infringe these two UT patents. In response, Hydro-Québec and the UT countersued us in the Federal Courts in Texas. Both cases are currently stayed pending re-examination of these patents by the U.S. Patent Office. The re-examination of these patents is complete, but the stay continues, although the litigation could resume at any time. For a more detailed discussion of our patent litigation, see "Business—Legal Proceedings."

        We believe that we have valid non-infringement defenses against both of these patents and that at least one of the patents is invalid. If we were to challenge the validity of any issued United States patent in court, we would need to overcome a presumption of validity that attaches to every patent. This burden is high and would require us to present clear and convincing evidence as to the invalidity of the patent's claims. There is no assurance that a court would find in our favor on infringement or validity and, if this case is not resolved in our favor, we may be required to pay substantial damages. In addition, an adverse ruling could cause us, and our customers, development partners and licensees, to stop, modify or delay activities in the United States such as research, development, manufacturing and sales of products based on technologies covered by these patents. We would need to develop products and technologies that design around these patents or obtain a license to the appropriate patent. There is no certainty that such design-arounds exist or if they exist that they would be commercially competitive, and there is no certainty that a license from the appropriate parties could be obtained. Also, the mere existence, and the uncertainty with respect to the ultimate outcome, of this patent litigation or any other patent litigation that we may become involved with, could cause our current and potential customers, development partners, the federal or state governments and licensees to stop, delay or avoid doing business with us or modify the extent to which they are willing to do business with us, and this loss or delay of business could harm our operating results and our ability to execute on our business plan.

Other parties may also bring intellectual property infringement claims against us which would be time-consuming and expensive to defend, and if any of our products or processes is found to be infringing, we may not be able to procure licenses to use patents necessary to our business at reasonable terms, if at all.

        Our success depends in part on avoiding the infringement of other parties' patents and proprietary rights. We may inadvertently infringe existing third-party patents or third-party patents issued on existing patent applications. In the United States and most other countries, patent applications are published 18 months after filing. As a result, there may be third-party pending patent applications of which we are unaware, and which we may infringe once they issue. These third parties could bring claims against us that, even if resolved in our favor, could cause us to incur substantial expenses and, if resolved against us, could cause us to pay substantial damages. Under some circumstances in the United States, these damages could be triple the actual damages the patent holder incurs. If we have supplied infringing products to third parties for marketing or licensed third parties to manufacture, use or market infringing products, we may be obligated to indemnify these third parties for any damages they may be required to pay to the patent holder and for any losses the third parties may sustain themselves as the result of lost sales or damages paid to the patent holder. In addition, we may have, and may be required to, make representations as to our right to supply and/or license intellectual property and to our compliance with laws. Such

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representations are usually supported by indemnification provisions requiring us to defend our customers and otherwise make them whole if we license or supply products that infringe on third party technologies or violate government regulations. Further, if a patent infringement suit were brought against us, we and our customers, development partners and licensees could be forced to stop or delay research, development, manufacturing or sales of products based on our technologies in the country or countries covered by the patent we infringe, unless we can obtain a license from the patent holder. Such a license may not be available on acceptable terms, or at all, particularly if the third party is developing or marketing a product competitive with products based on our technologies. Even if we were able to obtain a license, the rights may be nonexclusive, which would give our competitors access to the same intellectual property.

        Any successful infringement action brought against us may also adversely affect marketing of products based on our technologies in other markets not covered by the infringement action. Furthermore, we may suffer adverse consequences from a successful infringement action against us even if the action is subsequently reversed on appeal, nullified through another action or resolved by settlement with the patent holder. As a result, any infringement action against us would likely harm our competitive position, be costly and require significant time and attention of our key management and technical personnel.

We may be involved in lawsuits to protect or enforce our patents, which could be expensive and time consuming.

        Competitors or others may infringe our patents. To counter infringement or unauthorized use, we may be required to file patent infringement claims, which can be expensive and time-consuming. In addition, in an infringement proceeding, a court may decide that a patent of ours is not valid or is unenforceable, or may refuse to stop the other party from using the technology at issue on the grounds that our patents do not cover that technology. An adverse determination of any litigation or defense proceedings could put one or more of our patents at risk of being invalidated or interpreted narrowly and could put our patent applications at risk of not issuing.

        Interference proceedings brought by the United States Patent and Trademark Office may be necessary to determine the priority of inventions with respect to our patent applications. Litigation or interference proceedings may fail and, even if successful, may result in substantial costs and be a distraction to our management. We may not be able to prevent misappropriation of our proprietary rights, particularly in countries where the laws may not protect such rights as fully as in the United States.

        Furthermore, because of the substantial amount of discovery required in connection with intellectual property litigation, there is a risk that some of our confidential information could be compromised by disclosure. In addition, during the course of this litigation, there could be public announcements of the results of hearings, motions or other interim proceedings or developments. If securities analysts or investors perceive these results to be negative, it could have a substantial adverse effect on the price of our common stock.

        We may not prevail in any litigation or interference proceeding in which we are involved. Even if we do prevail, these proceedings can be expensive and distract our management.

Our patent applications may not result in issued patents, which may have a material adverse effect on our ability to prevent others from commercially exploiting products similar to ours.

        Patent applications in the United States are maintained in secrecy until the patents are published or are issued. Since publication of discoveries in the scientific or patent literature tends to lag behind actual discoveries by several months, we cannot be certain that we are the first creator of inventions covered by pending patent applications or the first to file patent applications on these inventions. We also cannot be certain that our pending patent applications will result in issued patents or that any of our issued patents will afford protection against a competitor. In addition, patent applications filed in foreign countries are subject to laws, rules and procedures that differ from those of the United States, and thus we cannot be certain that foreign patent applications related to issued U.S. patents will be issued. Furthermore, if these

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patent applications issue, some foreign countries provide significantly less effective patent enforcement than in the United States.

        The status of patents involves complex legal and factual questions and the breadth of claims allowed is uncertain. Accordingly, we cannot be certain that the patent applications that we file will result in patents being issued, or that our patents and any patents that may be issued to us in the near future will afford protection against competitors with similar technology. In addition, patents issued to us may be infringed upon or designed around by others and others may obtain patents that we need to license or design around, either of which would increase costs and may adversely affect our operations.

Our patents and other protective measures may not adequately protect our proprietary intellectual property.

        We regard our intellectual property, particularly our proprietary rights in our battery and battery system technology, as critical to our success. We have received a number of patents, and filed other patent applications, for various applications and aspects of our technology or processes and other intellectual property. In addition, we generally enter into confidentiality and invention agreements with our employees and consultants. Such patents and agreements and various other measures we take to protect our intellectual property from use by others may not be effective for various reasons, including the following:

    our pending patent applications may not be granted for various reasons, including the existence of conflicting patents or defects in our applications;

    the patents we have been granted may be challenged, invalidated or circumvented because of the pre-existence of similar patented or unpatented intellectual property rights or for other reasons;

    parties to the confidentiality and invention agreements may have such agreements declared unenforceable or, even if the agreements are enforceable, may breach such agreements;

    the costs associated with enforcing patents, confidentiality and invention agreements or other intellectual property rights may make aggressive enforcement prohibitive;

    even if we enforce our rights aggressively, injunctions, fines and other penalties may be insufficient to deter violations of our intellectual property rights; and

    other persons may independently develop proprietary information and techniques that are functionally equivalent or superior to our intellectual proprietary information and techniques but do not breach our patented or unpatented proprietary rights.

We may be unable to adequately prevent disclosure of trade secrets and other proprietary information.

        We rely on trade secrets to protect our proprietary technologies, especially where we do not believe patent protection is appropriate or obtainable. However, trade secrets are difficult to protect. We rely in part on confidentiality agreements with our employees, contractors, consultants, outside scientific collaborators and other advisors to protect our trade secrets and other proprietary information. These agreements may not effectively prevent disclosure of confidential information and may not provide an adequate remedy in the event of unauthorized disclosure of confidential information. In addition, others may independently discover our trade secrets or independently develop processes or products that are similar or identical to our trade secrets, and courts outside the United States may be less willing to protect trade secrets. Costly and time-consuming litigation could be necessary to enforce and determine the scope of our proprietary rights, and failure to obtain or maintain trade secret protection could adversely affect our competitive business position.

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Risks Associated With Doing Business Internationally and Specifically in China

Our substantial international operations subject us to a number of risks, including unfavorable political, regulatory, labor and tax conditions.

        We have significant manufacturing facilities and operations in China and Korea that are subject to the legal, political, regulatory and social requirements and economic conditions in these jurisdictions. In addition, we expect to sell a significant portion of our products to customers located outside the United States. Risks inherent to international operations and sales, include, but are not limited to, the following:

    difficulty in enforcing agreements, judgments and arbitration awards in foreign legal systems;

    fluctuations in exchange rates may affect product demand and may adversely affect our profitability in U.S. dollars to the extent the cost of raw materials and labor is denominated in a foreign currency;

    impediments to the flow of foreign exchange capital payments and receipts due to exchange controls instituted by certain foreign governments and the fact that the local currencies of these countries are not freely convertible;

    inability to obtain, maintain or enforce intellectual property rights;

    changes in general economic and political conditions;

    changes in foreign government regulations and technical standards, including additional regulation of rechargeable batteries, power technology, or the transport of lithium or phosphate, which may reduce or eliminate our ability to sell or license in certain markets;

    requirements or preferences of foreign nations for domestic products could reduce demand for our products;

    trade barriers such as export requirements, tariffs, taxes and other restrictions and expenses, which could increase the prices of our products and make us less competitive; and

    longer payment cycles typically associated with international sales and potential difficulties in collecting accounts receivable, which may reduce the future profitability of foreign sales.

        Our business in foreign jurisdictions requires us to respond to rapid changes in market conditions in these countries. Our overall success as a global business depends on our ability to succeed in different legal, regulatory, economic, social and political situations and conditions. We may not be able to develop and implement effective policies and strategies in each foreign jurisdiction where we do business. Also, each of the foregoing risks will likely take on increased significance as we implement plans to expand foreign manufacturing operations.

Since many of our products are manufactured in China, we own and lease manufacturing facilities in China and the Chinese market is of growing importance for our products, we face risks if China loses normal trade relations status with the United States or if US-China trade relations are otherwise adversely impacted.

        We manufacture and export our products from China and own and lease manufacturing facilities in China. We may also sell our products in China in the future. Our products sold in the United States have normal trade relations status and are currently not subject to United States import duties. As a result of opposition to certain policies of the Chinese government and China's growing trade surpluses with the United States, there has been, and in the future may be, opposition to normal trade relations status with China. The United States Congress may also introduce China trade legislation targeting currency manipulation, which may adversely affect our business in China. The loss of normal trade relations status for China, changes in current tariff structures or adoption in the United States of other trade policies

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adverse to China, and any retaliatory measures that impact our products in the Chinese market, could have an adverse effect on our business.

        A change in exchange rates mandated by legislation could negatively impact the cost of imported raw materials and products.

        Furthermore, our business and operations may be adversely affected by deterioration of the diplomatic and political relationships between the United States and China. If the relationship between the United States and China were to materially deteriorate, it could negatively impact our ability to control our operations and relationships in China, enforce any agreements we have with Chinese partners or otherwise deal with any assets or investments we may have in China.

Our ongoing manufacturing operations in China are complex and having these remote operations may divert management's attention, lead to disruptions in operations, delay implementation of our business strategy and make it difficult to establish adequate management and financial controls in China. Our plans to grow our business to include sales to Chinese customers may necessitate additional management attention to establishing and maintaining one or more joint venture relationships with Chinese parties.

        Currently, we have most of our manufacturing operations in China. We may not be able to find or retain suitable employees in China and we may have to train personnel to perform necessary functions for our manufacturing, senior management and development operations. This may divert management's attention, lead to disruptions in operations and delay implementation of our business strategy, all of which could negatively impact our profitability.

        China has only recently begun to adopt management and financial reporting concepts and practices like those with which investors in the United States are familiar. We may have difficulty in hiring and retaining employees in China who have the experience necessary to implement the kind of management and financial controls that are expected of a United States public company. If we cannot establish and implement such controls, we may experience difficulty in collecting financial data and preparing financial statements, books of account and corporate records and instituting business practices that meet U.S. standards.

        Growing our business to include sales to Chinese customers may involve us entering into a Chinese-foreign joint venture with a Chinese partner. A Chinese-foreign joint venture can be a complex business arrangement requiring substantial management attention to the joint venture relationship. The joint venture will also require capital contributions and due to China's foreign exchange controls, uncertainty as to the ability to repatriate profits and principal out of China.

Because of the relative weakness of the Chinese legal system in general, and the intellectual property regime in particular, we may not be able to enforce intellectual property rights in China.

        The legal regime protecting intellectual property rights in China is weak. Because the Chinese legal system in general, and the intellectual property regime in particular, are relatively weak, it is often difficult to create and enforce intellectual property rights in China. Accordingly, we may not be able to effectively protect our intellectual property rights in China.

Enforcing agreements and laws in China is difficult and may be impossible because China does not have a comprehensive system of laws.

        We depend on our relationships with our Chinese manufacturing partners. In China, enforcement of contractual agreements may be sporadic, and implementation and interpretation of laws may be inconsistent. The Chinese judiciary is relatively inexperienced in interpreting agreements and enforcing China's laws, leading to a higher than usual degree of uncertainty as to the outcome of any litigation. Even

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where adequate law exists in China, it may not be possible to obtain swift and equitable enforcement of such law, or to obtain enforcement of a judgment or an arbitration award by a court of another jurisdiction.

The government of China may change or even reverse its policies of promoting private industry and foreign investment, in which case our assets and operations may be at risk.

        Our existing and planned operations in China are subject to risks related to the business, economic and political conditions in China, which include the possibility that the central government of China will change or even reverse its policies of promoting private industry and foreign investment in China. The government of China has exercised and continues to exercise substantial control over virtually every section of the Chinese economy through regulation and state ownership. Many of the current reforms which support private business in China are of recent origin or provisional in nature. Other political, economic and social factors, such as political changes, changes in the rates of economic growth, unemployment or inflation, or in the disparities of per capita wealth among citizens of China and between regions within China, could also lead to further readjustment of the government's reform measures. It is not possible to predict whether the Chinese government will continue to be as supportive of private business in China, nor is it possible to predict how any future reforms will affect our business. For example, if the government were to limit the number of foreign personnel who could work in the country, substantially increase taxes on foreign businesses, eliminate export processing zones, restrict the transportation of goods in and out of the country, adopt policies favoring competitors or impose other restrictions on our operations, the impact may be significant.

        Significantly, a reversal of current liberalizations of foreign exchange controls by the Chinese government could be disruptive and costly to our cross-border operations and our business as a whole.

Business practices in China and Korea may entail greater risk and dependence upon the personal relationships of senior management than is common in North America, and therefore some of our agreements with other parties in China and Korea could be difficult or impossible to enforce.

        The business cultures of China and Korea are, in some respects, different from the business cultures in Western countries and may present some difficulty for Western investors reviewing contractual relationships among companies in China and Korea and evaluating the merits of an investment. Personal relationships among business principals of companies and business entities in China and Korea are very significant in their business cultures. In some cases, because so much reliance is based upon personal relationships, written contracts among businesses in China and Korea may be less detailed and specific than is commonly accepted for similar written agreements in Western countries. In some cases, material terms of an understanding are not contained in the written agreement but exist as oral agreements only. In other cases, the terms of transactions which may involve material amounts of money are not documented at all. In addition, in contrast to Western business practices where a written agreement specifically defines the terms, rights and obligations of the parties in a legally-binding and enforceable manner, the parties to a written agreement in China or Korea may view that agreement more as a starting point for an ongoing business relationship which will evolve and require ongoing modification. As a result, written agreements in China or Korea may appear to the Western reader to look more like outline agreements that precede a formal written agreement. While these documents may appear incomplete or unenforceable to a Western reader, the parties to the agreement in China or Korea may feel that they have a more complete understanding than is apparent to someone who is only reading the written agreement without having attended the negotiations. As a result, contractual arrangements in China and Korea may be more difficult to review and understand.

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China has introduced sweeping reforms to its income tax, turnover tax and other tax laws and regulations. Some of the changes increase the taxes foreign-invested and other businesses in China will incur on specific types of transactions as well as arising from operations generally in China. Our earnings may be affected by tax adjustments to reflect such changes in the law.

        Pursuant to a comprehensive reform of China's tax system that took effect on January 1, 2008, income tax incentives granted to foreign-invested enterprises, and geographically-based incentives, have largely been eliminated and have been replaced with incentives designed to encourage enterprises, domestic and foreign-invested alike, in selected industries. For example, dividends paid by foreign-invested enterprises to foreign shareholders are no longer exempt from withholding tax. A 10% withholding tax applies to dividends, although the rate is reduced to 5% by certain tax treaties. The tax holidays and tax reduction periods and the reduced national income tax rate that foreign-invested enterprises engaged in production used to enjoy have also been removed. The tax incentives promised to our wholly foreign-owned subsidiaries located in export processing zones at the time of inception will be phased-out by the end of 2012. At that time, these subsidiaries and any new foreign-invested enterprises we might establish as part of our strategy to expand the market for our products will no longer have income tax advantages over Chinese domestic businesses.

        China's turnover tax system consists of VAT, consumption tax and business tax. VAT is primarily imposed on import and sales of goods and certain services, such as repairing, processing and replacement. Export sales are exempt under VAT rules, and an exporter who incurs VAT on the purchase or manufacture of goods should be able to claim a refund from Chinese tax authorities. Depending on whether VAT export refund rates are raised or reduced for relevant goods, exporters might bear part of the VAT they incurred in conjunction with producing the exported goods. To mitigate the effects of the global economic downturn on China's export industry, the PRC Ministry of Finance and the State Administration of Taxation have raised VAT rebates on numerous exported labor-intensive and high-value-added products. However, the Chinese government may also lower rebate rates in future in response to different economic and policy objectives.

        China has also introduced sweeping VAT policy reforms with effect from January 1, 2009, which facilitate China's shift from a production-based VAT scheme to a consumption-based system. Generally, the new system reduces the total output VAT of production enterprises as fixed-asset investment costs related to VAT-eligible output are no longer subject to VAT. However, our VAT costs will depend on our ability to pass on input VAT to our local suppliers and customers. As the relevant VAT law and implementing regulations are new, there may be a period of adjustment before any cost-savings are realized.

        Business tax is usually a fee of 3-5 percent levied on services—such as transport, construction, education, finance, and insurance—transfer of intangible assets, and sales of fixed assets, none of which are generally eligible for VAT. New business tax regulations, which took effect January 1, 2009, may impose business on services exchanged among China- and foreign-based entities which previously were not subject to business tax, and the potential overall impact is to increase the tax burden of cross-border service transactions.

        Frequent changes to China's tax laws can result in uncertainty and unpredictability in financial results of our operations in China. China's tax laws are supplemented with detailed implementation rules and circulars. However, the interpretation of the rules may vary among local tax authorities.

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Risks Related to this Offering and Ownership of Our Common Stock

We will incur increased costs and demands upon management as a result of complying with the laws and regulations affecting public companies, which could harm our operating results.

        As a public company, we will incur significant additional legal, accounting and other expenses that we did not incur as a private company, including costs associated with public company reporting requirements. We also have incurred and will incur costs associated with current corporate governance requirements, including requirements under Section 404 and other provisions of the Sarbanes-Oxley Act, as well as rules implemented by the Securities and Exchange Commission, or SEC, and the exchange on which we list our shares of common stock issued in this offering. The expenses incurred by public companies for reporting and corporate governance purposes have increased dramatically in recent years. We expect these rules and regulations to substantially increase our legal and financial compliance costs and to make some activities more time-consuming and costly. We are unable to currently estimate these costs with any degree of certainty. We also expect these new rules and regulations may make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage previously available. As a result, it may be more difficult for us to attract and retain qualified individuals to serve on our board of directors or as our executive officers.

An active trading market for our common stock may not develop, and you may not be able to resell your shares at or above the initial public offering price.

        Prior to this offering, there has been no public market for shares of our common stock. Although we have applied to have our common stock approved for quotation on the NASDAQ Global Market, an active trading market for our shares may never develop or be sustained following this offering. The initial public offering price of our common stock will be determined through negotiations between us and the underwriters. This initial public offering price may not be indicative of the market price of our common stock after the offering. In the absence of an active trading market for our common stock, investors may not be able to sell their common stock at or above the initial public offering price or at the time that they would like to sell.

Our stock price may be volatile, and the market price of our common stock after this offering may drop below the price you pay.

        The market price of our common stock could be subject to significant fluctuations after this offering, and it may decline below the initial public offering price. Market prices for securities of early stage companies have historically been particularly volatile. As a result of this volatility, you may not be able to sell your common stock at or above the initial public offering price. Some of the factors that may cause the market price of our common stock to fluctuate include:

    fluctuations in our quarterly financial results or the quarterly financial results of companies perceived to be similar to us;

    fluctuations in our recorded revenue, even during periods of significant sales order activity;

    changes in estimates of our financial results or recommendations by securities analysts;

    failure of any of our products to achieve or maintain market acceptance;

    product liability issues involving our products or our competitors' products;

    changes in market valuations of similar companies;

    success of competitive products or technologies;

    changes in our capital structure, such as future issuances of securities or the incurrence of debt;

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    announcements by us or our competitors of significant services, contracts, acquisitions or strategic alliances;

    developments or announcements related to our application for government stimulus funds;

    regulatory developments in the United States, foreign countries or both;

    litigation involving us, our general industry or both;

    additions or departures of key personnel;

    investors' general perception of us; and

    changes in general economic, industry and market conditions.

        In addition, if the market for technology stocks or the stock market in general experiences a loss of investor confidence, the trading price of our common stock could decline for reasons unrelated to our business, financial condition or results of operations. If any of the foregoing occurs, it could cause our stock price to fall and may expose us to class action lawsuits that, even if unsuccessful, could be costly to defend and a distraction to management.

A significant portion of our total outstanding shares may be sold into the public market in the near future, which could cause the market price of our common stock to drop significantly, even if our business is doing well.

        Sales of a substantial number of shares of our common stock in the public market could occur at any time after the expiration of the lock-up agreements described in the "Underwriters" section of this prospectus. These sales, or the market perception that the holders of a large number of shares intend to sell shares, could reduce the market price of our common stock. Based on shares outstanding as of August 31, 2009, upon completion of this offering, we will have outstanding 96,816,482 shares of common stock, assuming no exercise of the underwriters' over-allotment option. This includes the 25,680,501 shares that we and the selling stockholders are selling in this offering, plus an additional 286,185 shares, which may be resold in the public market immediately. Of the remaining shares, 70,631,492 shares of common stock will be subject to a 180-day contractual lock-up with the underwriters, and 218,304 shares of common stock will be subject to a 180-day contractual lock-up with us. These shares will be able to be sold, subject to any applicable volume limitations under federal securities laws, after the earlier of the expiration of, or release from, the 180-day lock-up period. Morgan Stanley and Goldman, Sachs & Co., acting as co-representatives of the underwriters, may permit our officers, directors, employees and current stockholders who are subject to the contractual lock-up to sell shares prior to the expiration of the lock-up agreements.

        In addition, as of August 31, 2009, there were 10,493,698 shares subject to outstanding options that will become eligible for sale in the public market to the extent permitted by any applicable vesting requirements, the lock-up agreements and Rules 144 and 701 under the Securities Act of 1933, as amended. Moreover, after this offering, holders of an aggregate of approximately 63.1 million shares of our common stock as of August 31, 2009, will have rights, subject to some conditions, to require us to file registration statements covering their shares and to include their shares in registration statements that we may file for ourselves or other stockholders. Holders of an aggregate of approximately 3.3 million additional shares of our common stock as of August 31, 2009, will have rights, subject to some conditions, to include their shares in registration statements that we may file for ourselves or other stockholders. We also intend to register all shares of common stock that we may issue under our equity incentive plans, including 3,285,324 shares reserved for future issuance under our equity incentive plans. Once we register and issue these shares, they can be freely sold in the public market upon issuance, subject to the lock-up agreements.

        See the section titled "Shares Eligible for Future Sale" for a discussion of the lock-up agreements and other transfer restrictions.

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Purchasers in this offering will experience immediate and substantial dilution in the book value of their investment.

        The assumed initial public offering price of our common stock is substantially higher than the net tangible book value per share of our outstanding common stock immediately after this offering. Therefore, if you purchase our common stock in this offering, you will incur immediate dilution of $6.53 in net tangible book value per share from the price you paid. In addition, following this offering, purchasers in the offering will have contributed 42.9% of the total consideration paid by our stockholders to purchase shares of common stock. Moreover, we issued options in the past to acquire common stock at prices significantly below the assumed initial public offering price. As of August 31, 2009, 10,493,698 shares of common stock were issuable upon exercise of outstanding stock options with a weighted average exercise price of $5.54 per share. To the extent that these outstanding options are ultimately exercised, you will incur further dilution. For a further description of the dilution that you will experience immediately after this offering, see the "Dilution" section of this prospectus.

If securities or industry analysts do not publish or cease publishing research or reports about us, our business or our market, or if they change their recommendations regarding our stock adversely, our stock price and trading volume could decline.

        The trading market for our common stock will be influenced by the research and reports that industry or securities analysts may publish about us, our business, our market or our competitors. If any of the analysts who may cover us change their recommendation regarding our stock adversely, or provide more favorable relative recommendations about our competitors, our stock price would likely decline. If any analyst who may cover us were to cease coverage of our company or fail to regularly publish reports on us, we could lose visibility in the financial markets, which in turn could cause our stock price or trading volume to decline.

Our management will have broad discretion over the use of the proceeds we receive in this offering and might not apply the proceeds in ways that increase the value of your investment.

        Our management will have broad discretion to use our net proceeds from this offering, and you will be relying on the judgment of our management regarding the application of these proceeds. Our management might not apply our net proceeds of this offering in ways that increase the value of your investment. We expect to use the net proceeds to us from this offering for capital expenditures, including capital expenditures related to the expansion of our manufacturing capacity in Michigan, working capital, and other general corporate purposes, which may in the future include investments in, or acquisitions of, complementary businesses, joint ventures, partnerships, services or technologies. Our management might not be able to yield a significant return, if any, on any investment of these net proceeds. You will not have the opportunity to influence our decisions on how to use our net proceeds from this offering.

After the completion of this offering, we do not expect to declare any dividends in the foreseeable future.

        After the completion of this offering, we do not anticipate declaring any cash dividends to holders of our common stock in the foreseeable future. Consequently, investors may need to rely on sales of their common stock after price appreciation, which may never occur, as the only way to realize any future gains on their investment. Investors seeking cash dividends should not purchase our common stock.

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Anti-takeover provisions contained in our certificate of incorporation and bylaws, as well as provisions of Delaware law, could impair a takeover attempt.

        Our certificate of incorporation, bylaws and Delaware law contain provisions that could have the effect of rendering more difficult or discouraging an acquisition deemed undesirable by our board of directors. Our corporate governance documents include provisions:

    authorizing blank check preferred stock, which could be issued with voting, liquidation, dividend and other rights superior to our common stock;

    limiting the liability of, and providing indemnification to, our directors and officers;

    limiting the ability of our stockholders to call and bring business before special meetings and to take action by written consent in lieu of a meeting;

    requiring advance notice of stockholder proposals for business to be conducted at meetings of our stockholders and for nominations of candidates for election to our board of directors;

    controlling the procedures for the conduct and scheduling of board of directors and stockholder meetings;

    providing the board of directors with the express power to postpone previously scheduled annual meetings and to cancel previously scheduled special meetings;

    establishing a classified board of directors so that not all members of our board are elected at one time;

    limiting the determination of the number of directors on our board of directors and the filling of vacancies or newly created seats on the board to our board of directors then in office; and

    providing that directors may be removed by stockholders only for cause.

These provisions, alone or together, could delay hostile takeovers and changes in control of our company or changes in our management.

        As a Delaware corporation, we are also subject to provisions of Delaware law, including Section 203 of the Delaware General Corporation law, which prevents some stockholders holding more than 15% of our outstanding common stock from engaging in certain business combinations without approval of the holders of substantially all of our outstanding common stock. Any provision of our amended and restated certificate of incorporation or bylaws or Delaware law that has the effect of delaying or deterring a change in control could limit the opportunity for our stockholders to receive a premium for their shares of our common stock, and could also affect the price that some investors are willing to pay for our common stock.

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

        This prospectus contains forward-looking statements. All statements other than statements of historical facts contained in this prospectus, including statements regarding our future results of operations and financial position, business strategy and plans and objectives of management for future operations, are forward-looking statements. In many cases, you can identify forward-looking statements by terms such as "may," "will," "should," "expect," "plan," "anticipate," "could," "intend," "target," "project," "contemplate," "believe," "estimate," "predict," "potential" or "continue" or other similar words.

        These forward-looking statements are only predictions. These statements relate to future events or our future financial performance and involve known and unknown risks, uncertainties and other important factors that may cause our actual results, levels of activity, performance or achievements to materially differ from any future results, levels of activity, performance or achievements expressed or implied by these forward-looking statements. We have described in the "Risk Factors" section and elsewhere in this prospectus the principal risks and uncertainties that we believe could cause actual results to differ from these forward-looking statements. Because forward-looking statements are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified, you should not rely on these forward-looking statements as guarantees of future events.

        The forward-looking statements in this prospectus represent our views as of the date of this prospectus. We anticipate that subsequent events and developments will cause our views to change. However, while we may elect to update these forward-looking statements at some point in the future, we have no current intention of doing so except to the extent required by applicable law. You should, therefore, not rely on these forward-looking statements as representing our views as of any date subsequent to the date of this prospectus.

        This prospectus also contains estimates and other statistical data made by independent parties and by us relating to market size and growth and other data about our industry. This data involves a number of assumptions and limitations, and you are cautioned not to give undue weight to such estimates. We have not independently verified the statistical and other industry data generated by independent parties and contained in this prospectus and, accordingly, we cannot guarantee their accuracy or completeness. In addition, projections, assumptions and estimates of our future performance and the future performance of the industries in which we operate are necessarily subject to a high degree of uncertainty and risk.

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USE OF PROCEEDS

        We estimate that the net proceeds to us from this offering will be approximately $247.7 million and the net proceeds to the selling stockholders will be $6.8 million, assuming an initial public offering price of $10.75 per share, which is the midpoint of the range listed on the cover page of this prospectus, and after deducting estimated underwriting discounts and commissions and estimated offering expenses. The selling stockholders consist of our chief executive officer and all of our founders, including our chief technology officer and vice president of business development.

        A $0.75 increase (decrease) in the assumed initial public offering price of $10.75 per share would increase (decrease) the net proceeds to us from this offering by approximately $17.4 million, and increase (decrease) the net proceeds to the selling stockholders from this offering by $0.5 million, assuming the number of shares offered by us and the selling stockholders, as listed on the cover of this prospectus, remains the same.

        We intend to use the net proceeds to us from this offering for capital expenditures, including capital expenditures related to the expansion of our manufacturing capacity in Michigan, working capital and other general corporate purposes. The portion of the proceeds of this offering we use to expand our manufacturing capacity and the timing of the use thereof are subject to the pace at which we expand our manufacturing capacity. The pace at which we expand our manufacturing capacity depends on actual and anticipated future demand for our products. We may also use a portion of the net proceeds to us to expand our business through acquisitions of other companies, assets or technologies and to fund joint ventures with development partners. At this time we do not have any commitment to any specific acquisitions or to fund joint ventures. In addition, we may choose to use a part of the net proceeds from this offering to repay outstanding borrowings under our revolving line of credit or term loan from time to time. As of June 30, 2009, we had $8.0 million outstanding under this revolving line of credit. The interest rate on the revolving line of credit is prime, which was 3.25% at June 30, 2009. This revolving line of credit will expire in September 2010. As of June 30, 2009, we had $13.7 million outstanding under our term loan. Amounts borrowed under the term loan are repayable over a 36-month period beginning six months after the date of borrowing. The interest rate on the term loan is prime plus 0.75%.

        Some of the other principal purposes of this offering are to create a public market for our common stock, increase our visibility in the marketplace, and provide liquidity to existing stockholders. A public market for our common stock will facilitate future access to public equity markets and enhance our ability to use our common stock as a means of attracting and retaining key employees and as consideration for acquisitions. Depending on the future demand for our products and the pace at which we expand our manufacturing capacity, we may seek to raise additional capital to fund our manufacturing expansion.

        We will have broad discretion in the way that we use the net proceeds of this offering. The amounts that we actually spend for the purposes described above may vary significantly and will depend, in part, on the timing and amount of our future revenue, our future expenses and any potential acquisitions that we may pursue. Pending the uses of the net proceeds of this offering as described above, we intend to invest the net proceeds of this offering in investment-grade, interest-bearing securities including corporate, financial institution, federal agency and U.S. government obligations. See "Risk Factors—Risks Related to This Offering and Ownership of Our Common Stock—Our management will have broad discretion over the use of the proceeds we receive in this offering and might not apply the proceeds in ways that increase the value of your investment."


DIVIDEND POLICY

        We have never declared or paid any cash dividends on our capital stock and do not expect to pay any cash dividends for the foreseeable future. We intend to use future earnings, if any, in the operation and expansion of our business. Payment of future cash dividends, if any, will be at the discretion of our board of directors after taking into account various factors, including our financial condition, recent and expected operating results, current and anticipated cash needs, and restrictions imposed by lenders, if any.

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CAPITALIZATION

        The following table sets forth our capitalization as of June 30, 2009:

    on an actual basis;

    on a pro forma basis to give effect to the conversion of all of our outstanding preferred stock and redeemable common stock into common stock upon the completion of this offering on an assumed one-for-one basis, except for series E convertible preferred stock, which would convert on a one-for-1.38 basis; and

    on a pro forma basis as adjusted to give further effect to the issuance and sale by us of 25,000,000 shares of our common stock in this offering at an assumed initial public offering price of $10.75 per share, which is the midpoint of the range listed on the cover page of this prospectus, and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us. The pro forma as adjusted column gives effect to the automatic conversion of all of our outstanding convertible preferred stock on a one-for-one basis, except for series E convertible preferred stock, which will convert on a one-for-1.416 basis, and series F convertible preferred stock, which will convert on a one-for-1.085 basis upon the closing of this offering at an assumed initial public offering price of $10.75 per share.

        Our capitalization following the closing of this offering will be adjusted based upon the actual initial public offering price and other terms of the offering determined at pricing. You should read the following table together with our consolidated financial statements and the related notes appearing elsewhere in this prospectus and the "Management's Discussion and Analysis of Financial Condition and Results of Operations" section of this prospectus.

 
  As of June 30, 2009  
 
  Actual   Pro Forma   Pro Forma
As Adjusted
 
 
  (in thousands, except share
and per share data)

 

Total long-term debt, including current portion

  $ 16,238   $ 16,238   $ 16,238  
               

Preferred stock warrant liability

   
1,020
   
   
 
               

Redeemable convertible preferred stock:

                   
 

Series A redeemable convertible preferred stock, par value $0.001 per share, 8,312,087 shares authorized, 8,312,087 shares issued and outstanding, actual; no shares authorized, issued or outstanding, pro forma and pro forma as adjusted

   
8,377
   
   
 
 

Series A-1 redeemable convertible preferred stock, par value $0.001 per share, 2,925,000 shares authorized, 2,925,000 shares issued and outstanding, actual; no shares authorized, issued or outstanding, pro forma and pro forma as adjusted

   
4,356
   
   
 
 

Series B redeemable convertible preferred stock, par value $0.001 per share, 9,691,116 shares authorized, 9,623,750 shares issued and outstanding, actual; no shares authorized, issued or outstanding, pro forma and pro forma as adjusted

   
19,996
   
   
 
 

Series C redeemable convertible preferred stock, par value $0.001 per share, 9,047,719 shares authorized, 8,988,389 shares issued and outstanding, actual; no shares authorized, issued or outstanding, pro forma and pro forma as adjusted

   
30,283
   
   
 
 

Series D redeemable convertible preferred stock, par value $0.001 per share, 10,669,708 shares authorized, 10,669,708 shares issued and outstanding, actual; no shares authorized, issued or outstanding, pro forma and pro forma as adjusted

   
69,948
   
   
 

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  As of June 30, 2009  
 
  Actual   Pro Forma   Pro Forma
As Adjusted
 
 
  (in thousands, except share
and per share data)

 
 

Series E redeemable convertible preferred stock, par value $0.001 per share, 6,152,553 shares authorized, 6,152,553 shares issued and outstanding, actual; no shares authorized, issued or outstanding, pro forma and pro forma as adjusted

    102,016          
 

Series F redeemable convertible preferred stock, par value $0.001 per share, 10,862,226 shares authorized, 10,862,226 shares issued and outstanding, actual; no shares authorized, issued or outstanding, pro forma and pro forma as adjusted

   
99,596
   
   
 
               
 

Total redeemable convertible preferred stock

    334,572          
               

Redeemable common stock, par value $0.001 per share, 1,592,797 shares authorized, issued and outstanding, actual; no shares authorized, issued or outstanding, pro forma and pro forma as adjusted

   
11,500
   
   
 
               

Stockholders' equity (deficit):

                   
 

Series B-1 convertible preferred stock, par value $0.001 per share, 1,493,065 shares authorized, 1,493,065 shares issued and outstanding, actual; no shares authorized, issued or outstanding, pro forma and pro forma as adjusted

   
1
   
   
 
 

Common stock, par value $0.001 per share, 115,000,000 shares authorized, 7,697,248 shares issued and outstanding, actual; 250,000,000 shares authorized, 70,664,261 shares issued and outstanding, pro forma and 250,000,000 shares authorized, 96,816,482 shares issued and outstanding, pro forma as adjusted

   
8
   
71
   
97
 
 

Additional paid-in capital

   
23,679
   
370,709
   
613,814
 
 

Accumulated other comprehensive loss

   
(468

)
 
(468

)
 
(468

)
 

Accumulated deficit

   
(193,539

)
 
(193,539

)
 
(193,539

)
               
   

Total A123 Systems, Inc. stockholders' (deficit) equity

    (170,319 )   176,773     419,904  
               
   

Total capitalization

  $ 193,011   $ 193,011   $ 436,142  
               

        A $0.75 increase (decrease) in the initial public offering price of $10.75 per share would increase (decrease) total stockholders' equity in the pro forma as adjusted column by $17.4 million, assuming that the number of shares offered by us, as listed on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us.

        The pro forma column of the table above does not include:

    214,937 shares of our common stock issuable upon the automatic conversion of our outstanding series E convertible preferred stock due to a change in the conversion ratio for our series E convertible preferred stock immediately prior to the closing of this offering; and

    921,025 shares of our common stock issuable upon the automatic conversion of our outstanding series F convertible preferred stock due to a change in the conversion ratio for our series F convertible preferred stock immediately prior to the closing of this offering.

        The pro forma column and the pro forma as adjusted column of the table above do not include:

    10,244,577 shares of our common stock issuable upon the exercise of stock options outstanding as of June 30, 2009 at a weighted average exercise price of $5.40 per share;

    550,695 shares of our common stock reserved as of June 30, 2009 for future issuance under our stock compensation plans; and

    171,696 shares of our common stock issuable upon the exercise of warrants outstanding as of June 30, 2009, at a weighted average exercise price of $4.12 per share.

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DILUTION

        If you invest in our common stock in this offering, your ownership interest will be immediately diluted to the extent of the difference between the initial public offering price per share and the net tangible book value per share of our common stock after this offering. Our pro forma net tangible book value as of June 30, 2009, was $165.5 million, or $2.34 per share of our common stock. Pro forma net tangible book value per share represents the amount of our total tangible assets less our total liabilities, divided by the total number of shares of our common stock outstanding, after giving effect to the automatic conversion of all of our outstanding convertible preferred stock into common stock upon the closing of this offering.

        After giving effect to the sale by us of 25,000,000 shares of our common stock in this offering at an assumed initial public offering price of $10.75 per share, which is the midpoint of the range listed on the cover page of this prospectus, and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us, our pro forma net tangible book value as of June 30, 2009 would have been approximately $408.7 million, or $4.22 per share of our common stock. This amount represents an immediate increase in our pro forma net tangible book value of $1.88 per share to our existing stockholders and an immediate dilution in our pro forma net tangible book value of $6.53 per share to new investors purchasing shares of our common stock in this offering at the initial public offering price.

        The following table illustrates this dilution on a per share basis:

Assumed initial public offering price per share

        $ 10.75  
 

Pro forma net tangible book value per share as of June 30, 2009

  $ 2.34        
 

Increase per share attributable to this offering

    1.88        
             

Pro forma net tangible book value per share after this offering

        $ 4.22  
             

Dilution per share to new investors

        $ 6.53  
             

        An initial public offering price of $10.00 per share, which is the bottom of the range listed on the cover page of this prospectus, would decrease our pro forma net tangible book value per share after this offering by approximately $0.23 and would decrease dilution per share to new investors by approximately $0.52, assuming that the number of shares offered by us, as listed on the cover page of this prospectus, remains the same. In addition, to the extent any outstanding options or warrants are exercised, new investors will experience further dilution.

        An initial public offering price of $11.50 per share, which is the top of the range listed on the cover page of this prospectus, would increase our pro forma net tangible book value per share after this offering by approximately $0.23 and would increase dilution per share to new investors by approximately $0.52, assuming that the number of shares offered by us, as listed on the cover page of this prospectus, remains the same.

        If the underwriters exercise their over-allotment option in full, the pro forma as adjusted net tangible book value will increase to $4.44 per share, representing an immediate increase to existing stockholders of $0.22 per share and an immediate dilution of $6.31 per share to new investors. If any shares are issued upon exercise of outstanding options or warrants, you will experience further dilution.

        The following table summarizes, as of June 30, 2009, the number of shares purchased or to be purchased from us, the total consideration paid or to be paid to us, and the average price per share paid or to be paid to us by existing stockholders and new investors purchasing shares of our common stock in this offering at an assumed initial public offering price of $10.75 per share, which is the midpoint of the range listed on the cover page of this prospectus, before deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us. As the table below shows, new investors

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purchasing shares of our common stock in this offering will pay an average price per share substantially higher than our existing stockholders paid.

 
  Shares Purchased   Total Consideration    
 
 
  Average Price Per Share  
 
  Number   Percent   Amount   Percent  

Existing stockholders

    71,816,482     74.2 % $ 357,686,744     57.1 % $ 4.98  

New investors

    25,000,000     25.8     268,750,000     42.9     10.75  
                         

Total

    96,816,482     100 % $ 626,436,744     100 % $ 6.47  
                         

        A $0.75 increase (decrease) in the assumed initial public offering price of $10.75 per share would increase (decrease) the total consideration paid to us by new investors by $17.4 million and increase (decrease) the percent of total consideration paid to us by new investors by 1.7% assuming that the number of shares offered by us, as listed on the cover page of this prospectus, remains the same.

        The percentage of shares purchased from us by existing stockholders is based on 70,664,261 shares of our common stock outstanding as of June 30, 2009 after giving effect to the automatic conversion of all of our outstanding convertible preferred stock into common stock upon the closing of this offering. This number excludes:

    10,244,577 shares of our common stock issuable upon the exercise of stock options outstanding as of June 30, 2009, at a weighted average exercise price of $5.40 per share;

    550,695 shares of our common stock reserved as of June 30, 2009 for future issuance compensation plans; and

    171,696 shares of our common stock issuable upon the exercise of warrants outstanding as of June 30, 2009, at a weighted average exercise price of $4.12 per share.

        If all our outstanding stock options and outstanding warrants had been exercised as of June 30, 2009, assuming the treasury stock method, our pro forma net tangible book value as of June 30, 2009 would have been approximately $165.5 million or $2.18 per share of our common stock, and the pro forma net tangible book value after giving effect to this offering would have been $4.00 per share, representing dilution in our pro forma net tangible book value per share to new investors of $6.75.

        The sale of 680,501 shares of our common stock to be sold by the selling stockholders in this offering will reduce the number of shares of our common stock held by existing stockholders to 71,135,981, or 73.5% of the total shares outstanding, and will increase the number of shares of our common stock held by new investors to 25,680,501, or 26.5% of the total shares of our common stock outstanding.

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SELECTED CONSOLIDATED FINANCIAL DATA

        You should read the following selected financial data together with our consolidated financial statements and the related notes appearing elsewhere in this prospectus and the "Management's Discussion and Analysis of Financial Condition and Results of Operations" section of this prospectus. We have derived the annual consolidated financial data from our audited financial statements, the last three years of which are included elsewhere in this prospectus. We have derived the interim consolidated financial data from our unaudited interim consolidated financial statements included elsewhere in this prospectus. Our unaudited interim consolidated financial statements have been prepared on the same basis as the annual consolidated financial statements and include all adjustments, which include only normal recurring adjustments, necessary for the fair presentation of the information set forth therein. Our historical results for any prior period are not necessarily indicative of results to be expected in any future period, and our results for any interim period are not necessarily indicative of results for a full fiscal year.

 
  Years Ended December 31,   Six Months Ended June 30,  
 
  2004   2005   2006   2007   2008   2008   2009  
 
  (in thousands, except per share data)
 

Consolidated Statement of Operations Data:

                                           

Revenue

                                           

Product

  $   $   $ 28,346   $ 35,504   $ 53,514   $ 18,015   $ 36,638  

Research and development services

    109     749     6,002     5,845     15,011     3,919     6,284  
                               
   

Total revenue

    109     749     34,348     41,349     68,525     21,934     42,922  
                               

Cost of revenue

                                           

Product

                28,960     38,320     70,474     23,797     39,186  

Research and development services(1)

                4,417     4,499     10,295     2,878     4,505  
                                   
   

Total cost of revenue

                33,377     42,819     80,769     26,675     43,691  
                                   

Gross profit (loss)

                971     (1,470 )   (12,244 )   (4,741 )   (769 )
                                   

Operating expenses

                                           
 

Research and development

    3,945     11,164     8,851     13,241     36,953     15,094     22,814  
 

Sales and marketing

    315     862     1,537     4,307     8,851     3,606     4,227  
 

General and administrative

    1,608     3,000     6,129     13,336     21,544     8,831     12,452  
                               
   

Total operating expenses

    5,868     15,026     16,517     30,884     67,348     27,531     39,493  
                               

Operating loss

    (5,759 )   (14,277 )   (15,546 )   (32,354 )   (79,592 )   (32,272 )   (40,262 )
                               

Other income (expense)

                                           
 

Interest income

    169     378     871     1,729     1,258     614     62  
 

Interest expense

    (19 )   (422 )   (641 )   (716 )   (812 )   (407 )   (572 )
 

Gain (loss) on foreign exchange

                502     (724 )   76     (115 )
 

Unrealized loss on preferred stock warrant liability

            (362 )   (57 )   (286 )   (759 )   (70 )
                               

Other income (expense), net

    150     (44 )   (132 )   1,458     (564 )   (476 )   (695 )
                               

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  Years Ended December 31,   Six Months Ended June 30,  
 
  2004   2005   2006   2007   2008   2008   2009  
 
  (in thousands, except per share data)
 

Loss from operations, before tax

  $ (5,609 ) $ (14,321 ) $ (15,678 ) $ (30,896 ) $ (80,156 ) $ (32,748 ) $ (40,957 )

Provision for income taxes

            40     97     275     184     267  
                               
 

Loss from operations, net of tax

    (5,609 )   (14,321 )   (15,718 )   (30,993 )   (80,431 )   (32,932 )   (41,224 )

Cumulative effect of change in accounting principle

            (57 )                
                               

Net loss

    (5,609 )   (14,321 )   (15,775 )   (30,993 )   (80,431 )   (32,932 )   (41,224 )

Less: Net loss (income) attributable to the noncontrolling interest

                27     (39 )   (63 )   574  
                               

Net loss attributable to A123 Systems, Inc. 

    (5,609 )   (14,321 )   (15,775 )   (30,966 )   (80,470 )   (32,995 )   (40,650 )

Accretion to preferred stock

    (34 )   (35 )   (26 )   (35 )   (42 )   (20 )   (28 )
                               

Net loss attributable to A123 Systems, Inc. common stockholders

  $ (5,643 ) $ (14,356 ) $ (15,801 ) $ (31,001 ) $ (80,512 ) $ (33,015 ) $ (40,678 )
                               

Net loss per share attributable to common stockholders—basic and diluted

                                           
 

Loss per share attributable to common stockholders before cumulative effect of change in accounting principle

  $ (0.98 ) $ (2.48 ) $ (2.64 ) $ (4.88 ) $ (9.04 ) $ (3.85 ) $ (4.39 )
 

Cumulative effect of change in accounting principle

            (0.01 )                
                               
 

Net loss per share attributable to common stockholders—basic and diluted

  $ (0.98 ) $ (2.48 ) $ (2.65 ) $ (4.88 ) $ (9.04 ) $ (3.85 ) $ (4.39 )
                               

Weighted average number of common shares outstanding

    5,776     5,796     5,971     6,351     8,904     8,579     9,272  
                               

Pro forma net loss per share—basic and diluted

                          $ (1.47 )       $ (0.65 )
                                         

Pro forma weighted average common shares outstanding(2)

                            54,764           62,939  
                                         

Other Operating Data:

                                           

Shipments (in Wh)(3)

            20,016     32,010     44,900     15,423     27,663  

(Footnotes on the following page)

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  As of December 31,    
 
 
  As of
June 30,
2009
 
 
  2004   2005   2006   2007   2008  
 
  (in thousands)
 

Consolidated Balance Sheet Data:

                                     

Cash and cash equivalents

  $ 19,305   $ 5,900   $ 9,484   $ 23,359   $ 70,510   $ 114,877  

Working capital

    16,839     3,069     14,314     30,727     69,345     125,807  

Total assets

    24,667     18,562     47,668     105,146     208,960     269,408  

Preferred stock warrant liability

            694     664     950     1,020  

Long-term debt, including current portion

    156     3,623     5,404     6,071     10,522     16,238  

Redeemable convertible preferred stock

    32,560     32,595     62,884     132,914     234,954     334,572  

Redeemable common stock

                    11,500     11,500  

Total A123 Systems, Inc. stockholders' deficit

    (11,164 )   (24,637 )   (34,032 )   (62,603 )   (133,428 )   (170,319 )

(1)
In periods prior to 2006, we were a development stage company, and research and development costs of revenue were included in research and development operating expenses.

(2)
The pro forma weighted average common shares outstanding gives effect to the automatic conversion of all of our outstanding convertible preferred stock on a one-for-one basis, except for series E convertible preferred stock, which would convert on a one-for-1.38 basis, and redeemable common stock into common stock upon the closing of this offering.

(3)
We measure our product shipments in watt hours, or Wh, which refers to the aggregate amount of energy that could be delivered in a single complete discharge of a battery. We calculate watt hours for each of our battery models by multiplying the battery's amp hour, or Ah, storage capacity by the battery's voltage rating. For example, our 26650 battery is a 2.3 Ah battery that operates at 3.3 V, resulting in a 7.6 Wh rating. The Wh metric allows us and our investors to measure our manufacturing capacity and shipments, regardless of battery voltages and Ah specifications, utilizing a uniform and consistent metric.

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MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

        The following discussion and analysis of our financial condition and results of operations should be read together with our consolidated financial statements and the related notes and the other financial information appearing elsewhere in this prospectus. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in the forward-looking statements as a result of various factors, including those discussed below and elsewhere in this prospectus, particularly under "Risk Factors."

Overview

        We design, develop, manufacture and sell advanced, rechargeable lithium-ion batteries and battery systems. Our batteries and battery systems provide a combination of power, safety and life that we believe no other commercially available battery provides. Our target markets are the transportation, electric grid services and consumer markets.

        We market and sell our products primarily through a direct sales force. In the transportation market, we are focusing sales of our batteries and battery systems to automotive manufacturers either directly or through tier 1 suppliers. We work with automotive manufacturers directly to educate and inform them about the benefits of our technology for use in HEVs, PHEVs and EVs and are engaged in design and development efforts with several automotive manufacturers and tier 1 suppliers. At the same time, we work with tier 1 suppliers who are developing integrated solutions using our batteries. In the electric grid services market, our agreement with AES was initiated directly by our sales force. In the consumer market, our sales are made both directly and indirectly through distributors with key accounts managed by our sales personnel. We have entered into an exclusive agreement to license certain of our technology in the field of consumer electronic devices (excluding power tools and certain other consumer products) and expect to receive royalty fees on net sales of licensed products that include our technology. We expect to expand our sales presence in Europe and Asia as our business in those regions continues to grow. We expect international markets to provide increased opportunities for our products. We opened our first European sales office in Germany in May 2009.

        Our sales cycles vary by product and market segment. Most of our batteries and battery systems typically undergo a lengthy development and qualification period prior to commercial production. We expect that the total time from customer introduction to commercial production will range from three to five years depending on the specific product and market served. Our long and unpredictable sales cycles and the potential large size of battery supply and development contracts cause our period-to-period financial results to be susceptible to significant variability. Since most of our operating and capital expenses are incurred up-front based on the anticipated timing of estimated design wins and customer orders, the loss or delay of any such orders could have a material adverse effect on a period's results. The variability in our period-to-period results will also be driven by likely period-to-period variations in product mix and by the seasonality experienced by some of the end markets into which we sell our products.

        We have over 450,000 square feet of manufacturing facilities worldwide. Our primary manufacturing facilities are located in China, where we mass produce our batteries, from raw powder to finished batteries and battery modules using both our facilities and third-party contractors. We produce our prismatic batteries at our facilities in Icheon, Korea. We also have the capability to manufacture and assemble low-volume battery modules and battery systems at our energy solutions group facility in Hopkinton, Massachusetts.

        Our manufacturing facilities include a lease entered into in May 2009 for a new facility in Livonia, Michigan, and we began to incur costs related to the build out of this facility in July 2009. We also plan to consolidate our existing Novi and Ann Arbor, Michigan facilities at this location. We expect to begin production in the Livonia facility by the end of 2010.

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        We have been expanding our manufacturing capacity since inception, and we intend to further expand our manufacturing capacity by constructing more manufacturing lines. We intend to accelerate the expansion of our manufacturing capacity subject to actual and anticipated future demand for our products and the receipt of stimulus funds from the U.S. and state governments. We believe that increases in production capacity have had, and will continue to have, a significant effect on our financial condition and results of operations. We have made and continue to make significant up-front investments in our manufacturing capacity, which negatively impact earnings and cash balances, but we expect these investments will increase our revenue in the long term.

        Our research and development efforts are focused on developing new products and improving the performance of existing products. We fund our research and development initiatives both from internal and external sources. From inception through June 30, 2009, we have invested in excess of $109.0 million into our research and development activities. As part of our development strategy, certain customers fund or partially fund research and development efforts to design and customize batteries and battery systems for their specific applications.

        We were incorporated in 2001, and we began selling our first products commercially in the first quarter of 2006. Since inception through June 30, 2009, we have generated $188.2 million in revenue, consisting of $154.0 million from battery sales and $34.2 million from research and development services. Our revenue has grown from $41.3 million for the year ended December 31, 2007 to $68.5 million for the year ended December 31, 2008, and from $21.9 million for the six months ended June 30, 2008 to $42.9 million for the six months ended June 30, 2009. Total shipments measured in Wh have increased from 32.0 million Wh for the year ended December 31, 2007 to 44.9 million Wh for the year ended December 31, 2008, and from 15.4 million Wh for the six months ended June 30, 2008 to 27.7 million Wh for the six months ended June 30, 2009.

        We have continued to experience significant losses since inception, as we have continued to invest significantly in anticipation of growth in our business. In particular, we have invested in product development and sales and marketing in order to meet product requirements of our target markets and to secure design wins that may lead to strong revenue growth. We have also invested in the expansion of our manufacturing capacity to meet anticipated demand and our battery systems capabilities to provide battery systems solutions to our customers. We have funded these activities through private placements of capital stock and, to a lesser extent, with borrowings under notes payable and a revolving line of credit. As of June 30, 2009, we had an accumulated deficit of $193.5 million. As our business grows, the key factors to improving our financial performance will be revenue growth and revenue diversification into the transportation and electric grid services markets. Our revenue growth and revenue diversification will depend on our ability to secure design wins in the transportation and electric grid services markets. Higher revenue will also impact gross profit positively as higher production volumes will provide for increased absorption of manufacturing overhead and will reduce, on a percentage basis, the costs associated with increasing our production capacity.

Acquisitions

        On August 31, 2007, we acquired the outstanding capital stock of Enerland Co., Ltd. of South Korea, or Enerland, a battery company, for $14.3 million in cash. The purchase price was financed from the proceeds received from a private placement of preferred stock in August 2007.

        On February 23, 2007, we acquired substantially all of the assets of 2080418 Ontario Inc., d/b/a Hymotion, or Hymotion, which develops the Hymotion Battery Range Extender Module for converting HEVs to PHEVs. The aggregate purchase price was $0.1 million.

        On January 9, 2006, we acquired all of the outstanding capital stock of T/J Technologies, Inc., a company that provided contract research to various departments of the U.S. government. The aggregate

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purchase price of $6.8 million consisted of cash of $1.6 million, 1.5 million shares of our series B-1 convertible preferred stock, valued at $5.2 million, and transaction costs of $0.1 million.

Financial Operations Overview

    Revenue

        We derive revenue from product sales and research and development services.

        Product Revenue.    Product revenue is derived from the sale of our batteries and battery systems. Through June 30, 2009, product revenue represented 82% of our total revenue.

        A significant portion of our revenue is generated from a limited number of customers. Our three largest customers (BAE Systems, Black and Decker and Mercedes-Benz HighPerformanceEngines) accounted for approximately 72% of our total revenue during the six months ended June 30, 2009, and we expect that most of our revenue will continue to come from a relatively small number of customers for the foreseeable future. As we increase our focus on the transportation market, BAE Systems will represent a more substantial portion of our 2009 revenue, and the loss of BAE Systems as a customer could have a material adverse effect on our short-term revenue. Black and Decker has historically represented a significant portion of our revenue; however, we expect revenue from Black and Decker to decline in future periods as we increase our focus on the transportation and electric grid markets and Black and Decker engages additional suppliers for their battery requirements. We do not anticipate receiving any more revenue in 2009 from Mercedes-Benz HighPerformanceEngines.

        Research and Development Services Revenue.    Research and development services revenue is derived from contracts awarded by the U.S. federal government, other government agencies and commercial customers. These activities range from pure research, in which we investigate design techniques on new battery technologies at the request of a government agency or commercial customer, to custom development projects in which we are paid to enhance or modify an existing product or develop a new product to meet a customer's specifications. We expect to continue to perform funded research and development work and to use the technology developed to advance our new product development efforts. We expect that revenue from research and development services will vary period-to-period depending on the timing of cash payments received and, if applicable, the achievement of milestones. We expect that research development services revenue will decrease as a percentage of our total revenue due to the expected increase in product revenue.

        Deferred Revenue.    We record deferred revenue for product sales and research and development services in several different circumstances. These circumstances include (i) products delivered or services performed but other revenue recognition criteria have not been satisfied (ii) payments received in advance of products being delivered or services being performed and (iii) when all other revenue recognition criteria have been met, but we are not able to reasonably estimate the warranty expense. Deferred revenue includes customer deposits and up-front fees associated with research and development arrangements. Deferred revenue expected to be recognized as revenue more than one year subsequent to the balance sheet date is classified as long-term deferred revenue. Deferred revenue will vary depending on the timing and amount of cash receipts from customers and can vary significantly depending on specific contractual terms. As a result, deferred revenue is likely to fluctuate from period-to-period. During 2008, we received and recorded as deferred revenue a $25.0 million up-front payment in connection with our license agreement with Gillette. Under our exclusive license agreement with Gillette, Gillette paid us an up-front fee of $22.5 million and a support fee of $2.5 million. Gillette will also be required to pay us an additional license fee following the completion of a support period. In addition, the agreement requires Gillette to pay us royalty fees on net sales of products that include our technology. We have agreed with Gillette that if, during a certain period following execution of the license agreement, we enter into an agreement with a third party that materially restricts Gillette's license rights under the license agreement, then we may be

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required to refund to Gillette all license and support fees paid to us by Gillette under the license agreement, plus, in certain cases, an additional amount to cover Gillette's capital and other expenses paid and/or committed by Gillette in reliance upon its rights under the license agreement.

    Cost of Revenue and Gross Profit

        Cost of product revenue includes the cost of raw materials, labor and outside processing fees that are required for the development and manufacture of our products, as well as manufacturing overhead costs, inventory obsolescence charges, warranty costs and costs associated with increasing our production capacity. Raw material costs, which are our most significant cost item over the past two years, have historically been stable, but increasing energy costs for some of our materials are expected to increase this cost. This increase may be partially offset by process innovation, dual sourcing of materials and increased volume as we achieve better economies of scale. We incur costs associated with unabsorbed manufacturing expenses prior to a factory being qualified for commercial production. We expect these unabsorbed manufacturing costs, which include certain personnel, rent, utilities, materials, testing and depreciation costs, to increase in absolute dollars and as a percentage of revenue in the near term. Over the long term, if our revenues increase, we would expect these costs to decrease as a percentage of total revenue.

        Cost of research and development services revenue includes the direct labor costs of engineering resources committed to funded research and development contracts, as well as third-party consulting, and associated direct material costs. Additionally, we include overhead expenses such as occupancy costs associated with the project resources, engineering tools and supplies and program management expense.

        Our gross profit as a percentage of revenue is affected by a number of factors, including the mix of products sold, customer diversification, the mix between product revenue and research and development services revenue, average selling prices, foreign exchange rates, our actual manufacturing costs and costs associated with increasing production capacity until full production is achieved. As we continue to grow and build out our manufacturing capacity, and as new product designs come into production, our gross profit will continue to fluctuate from period-to-period. In addition, we currently manufacture initial production quantities of battery systems at our Hopkinton, Massachusetts facility.

    Operating Expenses

        Operating expenses consist of research and development, sales and marketing and general and administrative expenses. Personnel-related expenses comprise the most significant component of these expenses. We expect to hire a significant number of new employees in order to support our anticipated growth. In any particular period, the timing of additional hires could materially affect our operating expenses, both in absolute dollars and as a percentage of revenue.

        Research and Development Expenses.    Research and development expenses consist primarily of expenses for personnel engaged in the development of new products and the enhancement of existing products. These expenses also consist of lab materials, quality assurance activities and facilities costs and other related overhead. We expense all of our research and development costs as they are incurred. In the near term, we expect research and development expenses to increase in large part due to personnel-related expenses as we seek to hire additional employees, as well as contract-related expenses as we continue to invest in the development of our products. Research and development expense is reported net of any funding received under contracts with governmental agencies and commercial customers that are considered to be cost sharing arrangements with no contractually committed deliverable. Accordingly, we expect that our research and development expenses will continue to increase in absolute dollars but decrease as a percentage of revenue in the long term.

        Sales and Marketing Expenses.    Sales and marketing expenses consist primarily of personnel-related expenses, travel and other out-of-pocket expenses for marketing programs, such as trade shows, industry conferences, marketing materials and corporate communications, and facilities costs and other related

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overhead. We intend to hire additional sales personnel, initiate additional marketing programs and build additional relationships with resellers, systems integrators and strategic partners on a global basis. Accordingly, we expect that our sales and marketing expenses will continue to increase in absolute dollars but decrease as a percentage of revenue in the long term.

        General and Administrative Expenses.    General and administrative expenses consist primarily of personnel-related expenses related to our executive, legal, finance, human resource and information technology functions, as well as fees for professional services and allocated facility overhead expenses. Professional services consist principally of external legal, accounting, tax, audit and other consulting services. We expect general and administrative expenses to increase as we incur additional costs related to operating as a publicly-traded company, including increased audit and legal fees, costs of compliance with securities, corporate governance and other regulations, investor relations expenses and higher insurance premiums, particularly those related to director and officer insurance. In addition, we expect to incur additional costs as we hire personnel and enhance our infrastructure to support the anticipated growth of our business.

        Other Income (Expense), Net.    Other income (expense), net consists primarily of interest income on cash balances, interest expense on borrowings, change in fair value of preferred stock warrants and foreign currency-related gains and losses. We have historically invested our cash in money market investments. Our interest income will vary each reporting period depending on our average cash balances during the period and the current level of interest rates. Similarly, our foreign currency-related gains and losses will also vary depending upon movements in underlying exchange rates.

        Provision for Income Taxes.    Through the year ended December 31, 2008, we incurred net losses since inception and have not recorded provisions for U.S. federal income taxes since the tax benefits of our net losses have been offset by valuation allowances.

        We have recorded a tax provision for foreign taxes associated with our foreign subsidiaries and state income taxes where our net operating loss deductions are limited by statutes.

Watt Hours Operating Metric

        We measure our product shipments in watt hours, or Wh, which refers to the aggregate amount of energy that could be delivered in a single complete discharge by a battery. We calculate Wh for each of our battery models by multiplying the battery's amp hour, or Ah, storage capacity by the battery's voltage rating. For example, our 26650 battery is a 2.3 Ah battery that operates at 3.3 V, resulting in a 7.6 Wh rating. We determine a battery's Ah storage capacity at a specific discharge rate and a specific depth of discharge. We do this by charging the battery to its top voltage and by discharging it to zero capacity (2 volt charge level). The Wh metric allows us and our investors to measure our manufacturing capacity and shipments, regardless of battery voltages and Ah specifications, utilizing a uniform and consistent metric.

Application of Critical Accounting Policies and Estimates

        Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expense and related disclosures. We base our estimates and assumptions on historical experience and on various other factors that we believe to be reasonable under the circumstances. We evaluate our estimates and assumptions on an ongoing basis. Our actual results may differ from these estimates under different assumptions or conditions.

        We believe the following critical accounting policies, among others, affect our more significant judgments and estimates used in the preparation of our financial statements.

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    Revenue Recognition

        We recognize revenue in accordance with Staff Accounting Bulletin, or SAB, No. 104, Revenue Recognition, which states that revenue is realized or realizable and earned when all of the following criteria are met: persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price to the buyer is fixed or determinable, and collectibility is reasonably assured. In instances where final acceptance of the product is specified by the customer, revenue is deferred until all acceptance criteria have been met.

        Product revenue is generally recognized upon transfer of title and risk of loss, which is generally upon shipment, unless an acceptance period or other contingency exists. In general, our customary shipping terms are FOB shipping point or free carrier. In instances where customer acceptance of a product is required, revenue is either recognized upon the shipment when we are able to demonstrate the customer specific objective criteria have been met or the earlier of customer acceptance or expiration of the acceptance period.

        Research and development services revenue is recognized as services are performed consistent with the performance requirements of the contract using the proportional performance method. Where arrangements include milestones or governmental approval that impact the fees payable to us, revenue is limited to those amounts whereby collectibility is reasonably assured. We recognize revenue earned under time and materials contracts as services are provided based upon actual costs incurred plus a contractually agreed-upon profit margin. We recognize revenue from fixed-price contracts, using the proportional performance method based on the ratio of costs incurred to estimates of total expected project costs in order to determine the amount of revenue earned to date. Project costs are based on the direct salary and associated fringe benefits of the employees on the project plus all direct expenses incurred to complete the project that are not reimbursed by the client. The proportional performance method is used since reasonably dependable estimates of the revenues and costs applicable to various stages of a contract can be made. These estimates are based on historical experience and deliverables identified in the contract and are indicative of the level of benefit provided to our clients. There are no costs that are deferred and amortized over the contract term.

        If sales arrangements contain multiple elements, we apply the provisions of Emerging Issues Task Force, or EITF, Issue No. 00-21, Revenue Arrangements with Multiple Deliverables, or EITF 00-21, to determine if separate units of accounting exist within the arrangement. We have determined that, as of June 30, 2009, all sales arrangements should be accounted for as a single unit of accounting.

        Fees to license the use of our proprietary and licensed technologies are recognized only after both the license period has commenced and the technology has been delivered to the customer. Royalty revenue is recognized when it becomes determinable and collectibility is reasonably assured; otherwise we recognize revenue upon receipt of payment. To date, we have not recognized any license or royalty revenue.

        Because of the nature of our products, revenue recognition is based on a number of quantitative and qualitative factors. This can lead to significant fluctuations in our quarterly and annual revenues.

    Product Warranty Obligations

        We accrue for product warranty costs at the time revenue is recognized based on the historical rate of claims and costs to provide warranty services. Our standard warranty period extends one to five years from the date of sale, depending on the type of product purchased and its application. Our estimates of the amounts necessary to settle warranty claims are based primarily on our past experience. For our new products and products that remain under development, we will be required to base our warranty estimates on historical experience of similar products, testing of our batteries and battery systems, and performance information learned during our development activities with the customer. Although we believe our estimates are adequate and that the judgment we apply is appropriate, actual warranty costs could differ

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materially from our estimates. If we experience an increase in warranty claims above historical experience or our costs to provide warranty services increase, we would be required to increase our warranty accrual, and our cost of revenue would increase.

    Inventory

        We carry our inventory at the lower of historical cost or net realizable value assuming inventory items are consumed on a first-in, first-out basis. We recognize inventory losses based on obsolescence and levels in excess of forecasted demand. In these cases, inventory is written down to the estimated realizable value based on historical usage and expected demand. Inherent in our estimates of market value in determining inventory valuation are estimates related to economic trends, future demand for our products and technical obsolescence of our products. If future demand or market conditions are less favorable than our projections, additional inventory write-downs could be required and would be reflected in the cost of revenue in the period the revision is made.

    Business Combinations

        The purchase price of an acquisition accounted for as a purchase business combination is allocated to the tangible and intangible assets acquired based on their estimated fair values, with any amount in excess of such allocations designated as goodwill. Significant management judgment and assumptions are required in determining the fair value of acquired assets and liabilities, particularly acquired intangibles. For example, it is necessary to estimate the portion of development efforts that are associated with technology that is in process and has no alternative future use. The valuation of purchased intangibles is based upon estimates of the future performance and cash flows from the acquired business. Using different assumptions would materially impact the purchase price allocation and our financial position and results of operations.

    Impairment of Goodwill and Acquired Intangible Assets

        Goodwill and intangible assets with indefinite lives are tested at least annually for impairment. We evaluate these assets on an annual basis as of October 1 or more frequently if we believe indicators of impairment exist. In the process of our annual impairment review, we use the income approach methodology of valuation that includes the discounted cash flow method to determine the fair value of our intangible assets. Significant management judgment is required in the forecasts of future operating results that are used in the discounted cash flow method of valuation.

        The estimates we have used are consistent with the plans and estimates that we use to manage our business. If our actual results, or the plans and estimates used in future impairment analyses, are lower than the original estimates used to assess the recoverability of these assets, we could incur additional impairment charges.

        As a result of the decline in revenue from our Enerland subsidiary and the termination of a supply agreement with Enerland's most significant customer, we evaluated the intangible asset associated with the customer relationships for impairment. This evaluation resulted in a $1.4 million intangible asset impairment charge for the year ended December 31, 2008.

    Impairment of Long-Lived Assets

        We periodically evaluate our long-lived assets for events and circumstances that indicate a potential impairment in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. We review long-lived assets for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable or that the useful lives of these assets are no longer appropriate. Each impairment test is based on a comparison of the estimated undiscounted cash flows of the asset as compared to the recorded value of the asset. If these estimates or their related assumptions change in the future, we may be required to record impairment charges against these assets in the reporting period in which the impairment is determined.

        As a result of the decline in revenue from our Enerland subsidiary and the termination of the supply agreement with Enerland's largest customer, we concluded that impairment indicators existed. As a result, we reviewed our long-lived assets, principally equipment, associated with the production of small prismatic batteries and recorded a $1.7 million asset impairment charge for the year ended December 31, 2008.

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    Stock-Based Compensation

        We use the Black-Scholes option pricing model to determine the weighted average fair value of options granted. We recognize the compensation expense of share-based awards on a straight-line basis over the requisite service period of the award, which is generally the vesting period.

        The determination of fair value of share-based payment awards utilizing the Black-Scholes model is affected by the fair value of our common stock as of the time of grant and a number of assumptions, including expected volatility, expected life, risk-free interest rate and expected dividends.

        Prior to this offering, the fair value for our common stock, for the purpose of determining the exercise prices of our common stock options, was estimated by our board of directors, with input from management. Our board of directors exercised judgment in determining the estimated fair value of our common stock on the date of grant based on various factors, including:

    the prices for our convertible preferred stock sold to outside investors in arm's-length transactions;

    the rights, preferences and privileges of that convertible preferred stock relative to those of our common stock;

    our operating and financial performance;

    the hiring of key personnel;

    the introduction of new products;

    our stage of development and revenue growth;

    the lack of an active public market for our common and preferred stock;

    industry information such as market growth and volume;

    the performance of similarly-situated companies in our industry;

    the execution of strategic and development agreements;

    the risks inherent in the development and expansion of our products and services;

    the prices of our common stock sold to outside investors in arm's-length transactions; and

    the likelihood of achieving a liquidity event, such as an initial public offering or a sale of our company given prevailing market conditions and the nature and history of our business.

        We do not have a history of market prices, and as such, we estimate volatility in accordance with SEC SAB No. 107, Share-Based Payment, or SAB 107, using historical volatilities of similar companies. We based our analysis of expected volatility on reported data for a peer group of companies that issued options with substantially similar terms using an average of the historical volatility measures of this peer group of companies. Based on this analysis, the expected volatility for options granted during the years ended December 31, 2007 and 2008 was determined to be 63% and 66%, respectively. The expected life of options has been determined utilizing the "simplified" method as prescribed by the SAB 107, which uses the midpoint between the vesting date and the end of the contractual term. Accordingly, the expected life of options granted during the years ended December 31, 2007 and 2008 was 6.07 years and 6.14 years, respectively. The risk-free interest rate is based on a U.S. treasury instrument whose term is consistent with the expected life of the stock options and the weighted average risk-free interest rate range for the years ended December 31, 2007 and 2008 was 4.5-4.7% and 3.0-3.4%, respectively. We have not paid, and do not anticipate paying, cash dividends on our shares of common stock; therefore, the expected dividend yield was assumed to be zero. We utilize an estimated forfeiture rate when calculating the expense for the period. As a result, we applied estimated forfeiture rates of 0% and 11% for executive and non-executive awards, respectively, based on a review of our historical forfeitures, to determine the expense recorded in

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our statements of operations. If this estimated rate changes in future periods due to different actual forfeitures, our stock compensation expense may increase or decrease significantly. If there are any modifications or cancellations of the underlying unvested securities or the terms of the stock option, we may be required to accelerate, increase or cancel any remaining unamortized share-based compensation expense.

        We believe consideration of these factors by our board of directors was a reasonable approach to estimating the fair value of our common stock for those periods. Determining the fair value of our stock requires complex and subjective judgments, however, and there is inherent uncertainty in our estimate of fair value.

        The following table presents the grant dates and related exercise prices of stock options granted to employees during the year ended December 31, 2008 and the six months ended June 30, 2009:

Grants made during quarter ended
  Number of
Options Granted
  Weighted
Average Exercise
Price
 

March 31, 2008

    1,228,465   $ 7.00  

June 30, 2008

    514,450     11.69  

September 30, 2008

    298,600     13.28  

December 31, 2008

         

March 31, 2009

         

June 30, 2009

    2,235,560     9.48  

Grants issued subsequent to June 30, 2009

    350,000     10.00  
           

Total grants

    4,627,075   $ 9.35  

        Based upon the midpoint of the price range as set forth in the cover of this prospectus, the aggregate intrinsic value of our outstanding stock options as of December 31, 2008 was $54.2 million.

        The exercise price for stock options granted was determined by our board of directors based upon guidance set forth by the American Institute of Certified Public Accountants, or the AICPA, in the AICPA Technical Practice Aid, "Valuation of Privately-Held-Company Equity Securities Issued as Compensation", referred to herein as the AICPA Practice Aid.

        On April 5, 2007, we adopted the probability-weighted expected return method, as prescribed by the AICPA Practice Aid. This change in valuation model was precipitated by changes in our business that allowed us to forecast the occurrence of a liquidity event within two years. This valuation model took into consideration the following scenarios:

    three different scenarios for the completion of an initial public offering;

    a sale to a strategic acquirer at a price above the liquidation preference;

    a sale to an acquirer at a price at or below the liquidation preference; and

    remaining a private company.

        The valuation information we considered to determine the fair value of our common stock was based on the probability-weighted expected return method, liquidation preferences, progress towards a liquidity event and historical market data of recent liquidity transactions for similar companies.

        We allocated the enterprise value to preferred and common shares based on a scenario analysis, as set forth above, that incorporated our capital structure and the specific rights and preferences associated with our securities under these various liquidity scenarios. The plans of our board of directors and management, together with achieved operating results, dictated the timing and probability of the liquidity events used in

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the scenario analysis. Based on the foregoing, the board of directors determined the fair value of our common stock as follows:

        The fair value of our common stock as of January 18, 2008 was determined to be $6.84 per share. This valuation reflected marketability discounts of 10%. The probability of an initial public offering increased to 55%, the probability of a sale above the liquidation preference was weighted at 40% and the probability of a sale at or below the liquidation preference decreased to 5%. The increase in fair value was primarily due to the following:

    the price of $7.22 for the redeemable common stock we sold to a non-affiliated, outside investor in an arm's-length transaction on January 11, 2008;

    we signed a supply agreement with Think Global; and

    we extended the liquidity date from June 1, 2008 to September 1, 2008.

        The fair value of our common stock as of February 29, 2008 was determined to be $7.14 per share. This valuation reflected marketability discounts ranging from 10% to 15%, depending on the scenario. The probability of an initial public offering increased to 60%, the probability of a sale above the liquidation preference was weighted at 35% and the probability of a sale at or below the liquidation preference was weighted at 5%. The increase in fair value was primarily due to the following:

    we signed a definitive agreement with AES for the development and sale of a new utility megawatt power system; and

    we received approval from our board of directors to begin the formal initial public offering process.

        The fair value of our common stock as of May 12, 2008 was determined to be $11.69 per share. This valuation reflected marketability discounts ranging from 7% to 13%, depending on the scenario. The probability of an initial public offering was weighted at 60%, while the probability of a sale above the liquidation preference was weighted at 40%. The probability of a sale below the liquidation preference was considered zero. The increase in fair value was primarily due to the following:

    the price of $16.59 for the series E convertible preferred stock we sold to investors, including non-affiliated investors, in an arm's-length transaction on May 6, 2008;

    we launched our Hymotion product line website and began taking consumer orders for our Hymotion™ L5 plug-in conversion modules; and

    we made progress on the initial public offering process and moved closer to the assumed liquidity dates.

        The fair value of our common stock as of July 7, 2008 was determined to be $13.28 per share. This valuation reflected marketability discounts ranging from no discount to 8.5% depending on the scenario. The probability of an initial public offering was weighted at 75%, while the probability of a sale above the liquidation preference was weighted at 25% and the probability of a sale below the liquidation preference was considered zero. The increase in fair value was primarily due to the following:

    the price of $16.59 for the series E convertible preferred stock we sold to a non-affiliated investor in an arm's-length transaction on June 16, 2008; and

    we made progress on the initial public offering process and moved closer to the assumed liquidity dates.

        The fair value of our common stock as of May 14, 2009 was determined to be $9.11 per share. This valuation reflected marketability discounts ranging from no discount to 15% depending on the scenario. The probability of an initial public offering was weighted at 90%, while the probability of a sale above the

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liquidation preference was weighted at 10% and the probability of a sale below the liquidation preference was considered zero. The decrease in fair value was primarily due to the following:

    the price of $9.20 for the series F convertible preferred stock we sold to investors in an arm's-length transaction in April and May 2009; and

    current market and general economic conditions.

        The fair value of our common stock as of June 20, 2009 was determined to be $9.71 per share. This valuation reflected marketability discounts ranging from no discount to 10% depending on the scenario. The probability of an initial public offering was weighted at 90%, while the probability of a sale above the liquidation preference was weighted at 10% and the probability of a sale below the liquidation preference was considered zero. The increase in fair value was primarily due to the following:

    we made progress on the initial public offering process and moved closer to the assumed liquidity dates; and

    current market and general economic conditions.

        The fair value of our common stock as of August 31, 2009 was determined to be $10.00 per share. In August 2009, representatives of one of our managing underwriters provided us with an estimated valuation range for our initial public offering assuming an offering in the third quarter of 2009. After considering the estimated valuation range and these other factors, our board of directors concluded that the option exercise price for the August 31, 2009 options grants should be $10.00 per share.

    Grants to Non-Employees

        We account for equity instruments issued to the non-employee consultant in accordance with the provisions of SFAS No. 123(R) and EITF Issue No. 96-18, Accounting for Equity Instruments That are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services. All transactions in which goods or services are the consideration received for the issuance of equity instruments are accounted for based on the fair value of the consideration received or the fair value of the equity instrument issued, whichever is more reliably measurable. The measurement date of the fair value of the equity instrument issued is the date on which the counterparty's performance is complete. We believe that our assumptions, including the risk-free interest rate and expected life used to determine fair value, are appropriate. However, if different assumptions had been used, the fair value of the equity instruments issued to non-employee vendors would have been different from the amount we computed and recorded which would have resulted in either an increase or decrease in the compensation expense.

    Income Taxes

        We are subject to income taxes in both the United States and foreign jurisdictions, and we use estimates in determining our provisions for income taxes. We account for income taxes in accordance with the asset and liability method for accounting and reporting for income taxes. Deferred tax assets and liabilities are recognized based on temporary differences between the financial reporting and income tax bases of assets and liabilities using statutory rates.

        We assess the likelihood that deferred tax assets will be realized, and we recognize a valuation allowance if it is more likely than not that some portion of the deferred tax assets will not be realized. This assessment requires judgment as to the likelihood and amounts of future taxable income by tax jurisdiction. At December 31, 2007, we had a full valuation allowance against substantially all our deferred tax assets. Although we believe that our tax estimates are reasonable, the ultimate tax determination involves significant judgment that is subject to audit by tax authorities in the ordinary course of business.

        Effective January 1, 2007, we adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109, or FIN 48. FIN 48 prescribes a recognition

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threshold and a measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be more likely than not to be sustained upon examination by taxing authorities.

        We assess all material positions taken in any income tax return, including all significant uncertain positions, in all tax years that are still subject to assessment or challenge by relevant taxing authorities. Assessing an uncertain tax position begins with the initial determination of the position's sustainability and is measured at the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. As of each balance sheet date, unresolved uncertain tax positions must be reassessed, and we will determine whether (i) the factors underlying the sustainability assertion have changed and (ii) the amount of the recognized tax benefit is still appropriate. The recognition and measurement of tax benefits requires significant judgment. Judgments concerning the recognition and measurement of a tax benefit might change as new information becomes available.

Internal Control Over Financial Reporting

        We identified material weaknesses in our internal control over financial reporting. A material weakness is defined as a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company's annual or interim financial statements will not be prevented or detected on a timely basis by the company's internal controls. The material weaknesses related to our financial statement close process, revenue recognition, accrual processes, inventory costing, cost of sales, share-based compensation and information technology general controls.

        These material weaknesses were as follows:

    We did not have an adequate number of personnel in our accounting and finance department with sufficient technical accounting expertise and, as a result, we could not evaluate in a timely manner the accounting implications of our business transactions. For example, we did not properly recognize revenue related to our sale of batteries to one of our customers and we did not properly manage the accrual process related to cutoffs at the end of reporting periods.

    We did not design or maintain effective operating and information technology controls over the financial statement close and reporting process in order to ensure the accurate and timely preparation of financial statements in accordance with GAAP. For example, we did not compare our actual results to our budget, we allowed individuals to process journal entries without supervisor approval or review and by the end of 2007, we had not yet formalized information technology control policies in three of our manufacturing locations in China.

        In recent periods, our business has undergone significant changes. During 2007, we added 677 employees, we acquired Enerland and Hymotion, we shifted away from a manufacturing model that was based substantially on the use of third-party contract manufacturers and opened three manufacturing facilities in China and one in Hopkinton, Massachusetts, and, in late 2007, we implemented manufacturing ERP systems and an accounting system in each of our new manufacturing facilities. Our U.S. accounting department is responsible for establishment of GAAP policy, design of internal controls over financial reporting and consolidations on a global basis. From January 1, 2007 to December 31, 2008, we increased the number of people in our U.S. finance and accounting department from five to 17.

        We are in the process of taking necessary steps to remediate the material weaknesses that we identified. We will continue to review, revise, and improve the effectiveness of our internal controls as appropriate. Although we have made enhancements to our control procedures in this area, the material weaknesses will not be remediated until the necessary controls have been implemented and are operating effectively.

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    Remediation Efforts

        As part of our on-going remediation efforts and to improve our financial accounting organization and processes, we have hired several senior accounting personnel in the United States, including a corporate controller, director of corporate accounting, director of financial reporting and analysis and manufacturing controller. In addition, we have hired additional accounting staff for each of our six manufacturing facilities and have relocated one of our controllers to Korea. We believe the additional accounting staff in each of our manufacturing plants in China and Hopkinton has enabled us to address the issues associated with inventory costing and cost of sales.

        To improve our information technology organization, we have hired several senior managers who will manage our application systems, in the United States and in China, and several analysts. We believe the addition of these additional information technology resources has enabled us to address the time needed to review and analyze actual results compared to budget through the development of reporting systems. In addition, we have implemented approval controls for the processing of journal entries.

        We also have prepared and are continuing to prepare information technology policies and procedures on a global basis that will require password access and approved-user access to specific system modules. For example, we have reduced the risk of unauthorized access and unauthorized transactions being posted to our accounting records by requiring the approval of senior accounting personnel in order to access our financial systems.

        We are continuing to evaluate our staffing requirements in the areas of finance, accounting and international finance. As needed, we are augmenting our accounting staff with personnel from consulting and accounting firms. We are continuing to adopt and implement additional policies and procedures to strengthen our financial reporting capability including investments in further enhancements to, and expansion of, our enterprise resource planning system. However, the process of designing and implementing an effective financial reporting system is a continuous effort that requires us to anticipate and react to changes in our business and the economic and regulatory environments and to expend significant resources to maintain a financial reporting system that is adequate to satisfy our reporting obligations. For more information relating to the risks associated with our material weaknesses, see "Risk Factors—Risks Relating to Our Business—We have identified material weaknesses in our internal control over financial reporting and if we fail to remediate these weaknesses and maintain proper and effective internal controls, our ability to produce accurate and timely financial statements could be impaired, which could harm our operating results, our ability to operate our business and investors' views of us."

        We do not know the specific time frame needed to fully remediate the significant deficiencies identified. In addition, we expect to incur some incremental costs associated with this on-going remediation. If we fail to enhance our internal control over financial reporting to meet the demands that will be placed upon us as a public company, including the requirements of the Sarbanes-Oxley Act, we may be unable to report our financial results accurately. The actions we plan to take are subject to continued management review supported by confirmation and testing, as well as audit committee oversight. While we expect to fully remediate these material weaknesses, we cannot assure you that we will be able to do so in a timely manner, which could impair our ability to report our financial position.

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Results of Operations

        The following table sets forth our consolidated results of operations for the periods shown:

 
  Years Ended December 31,   Six Months Ended
June 30,
 
 
  2006   2007   2008   2008   2009  
 
  (Dollars in thousands, except per share data)
 

Consolidated Statement of Operations Data:

                               

Revenue

                               

Product

  $ 28,346   $ 35,504   $ 53,514   $ 18,015   $ 36,638  

Research and development services

    6,002     5,845     15,011     3,919     6,284  
                       
   

Total revenue

    34,348     41,349     68,525     21,934     42,922  
                       

Cost of revenue

                               

Product

    28,960     38,320     70,474     23,797     39,186  

Research and development services

    4,417     4,499     10,295     2,878     4,505  
                       
   

Total cost of revenue

    33,377     42,819     80,769     26,675     43,691  
                       
   

Gross profit (loss)

    971     (1,470 )   (12,244 )   (4,741 )   (769 )
                       

Operating expenses

                               
 

Research and development

    8,851     13,241     36,953     15,094     22,814  
 

Sales and marketing

    1,537     4,307     8,851     3,606     4,227  
 

General and administrative

    6,129     13,336     21,544     8,831     12,452  
                       
   

Total operating expenses

    16,517     30,884     67,348     27,531     39,493  
                       
   

Operating loss

    (15,546 )   (32,354 )   (79,592 )   (32,272 )   (40,262 )
                       

Interest income

    871     1,729     1,258     614     62  

Interest expense

    (641 )   (716 )   (812 )   (407 )   (572 )

Gain (loss) on foreign exchange

        502     (724 )   76     (115 )

Unrealized loss on preferred stock warrant liability

    (362 )   (57 )   (286 )   (759 )   (70 )
                       

Other income (expense), net

    (132 )   1,458     (564 )   (476 )   (695 )
                       

Loss from operations, before tax

    (15,678 )   (30,896 )   (80,156 )   (32,748 )   (40,957 )

Provision for income taxes

    40     97     275     184     267  
                       

Loss from operations, net of tax

    (15,718 )   (30,993 )   (80,431 )   (32,932 )   (41,224 )

Cumulative effect of change in accounting principle

    (57 )                
                       
   

Net loss

    (15,775 )   (30,993 )   (80,431 )   (32,932 )   (41,224 )

Less: Net loss (income) attributable to the noncontrolling interest

        27     (39 )   (63 )   574  
                       

Net loss attributable to A123 Systems, Inc. common stockholders

  $ (15,775 ) $ (30,966 ) $ (80,470 ) $ (32,995 ) $ (40,650 )
                       

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Other Operating Data:

 
  Years Ended December 31,   Six Months Ended
June 30,
 
 
  2006   2007   2008   2008   2009  
 
  (in thousands)
 

Shipments (in Wh)(1)

    20,016     32,010     44,900     15,423     27,663  

(1)
We measure our product shipments in watt hours, or Wh. We calculate watt hours for each of our battery models by multiplying the battery's amp hour, or Ah, storage capacity by the battery's voltage rating. For example, our 26650 battery is a 2.3 Ah battery that operates at 3.3 V, resulting in a 7.6 Wh rating. The Wh metric allows us and our investors to measure our manufacturing capacity and shipments, regardless of battery voltages and Ah specifications, utilizing a uniform and consistent metric.

    Six Months Ended June 30, 2008 and 2009

Revenue

 
  Six Months Ended
June 30,
  Change  
 
  2008   2009   $   %  
 
  (Dollars in thousands)
 

Product

                         
 

Consumer

  $ 17,477   $ 10,965   $ (6,512 )   (37.3 )%
 

Transportation

    538     25,673     25,135     N/M  
 

Electric grid

                0.0 %
                   

Total Product

    18,015     36,638     18,623     103.4 %

Research and development services

    3,919     6,284     2,365     60.3 %
                   

Total revenue

  $ 21,934   $ 42,922   $ 20,988     95.7 %
                   

        Product Revenue.    The increase in product revenue was primarily due to an increase in sales to customers in the transportation industry of $25.1 million. These increases were partially offset by a decrease of $3.9 million in sales generated by Enerland, which was attributable to the decline in demand for our radio controlled products, and a decrease of $2.6 million in sales to Black & Decker and its affiliates.

        Research and Development Services Revenue.    Revenue related to government agency research contracts increased by $1.4 million, and revenue related to commercial projects increased by $1.0 million. The increase in government agency research contract revenue was due to new project award grants. The increase in revenue from commercial projects was due to the timing of project milestones and revenue recognition on active projects.

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Cost of Revenue and Gross Profit (Loss)

 
  Six Months Ended
June 30,
  Change  
 
  2008   2009   $   %  
 
  (Dollars in thousands)
 

Cost of revenue

                         

Product

  $ 23,797   $ 39,186   $ 15,389     64.7 %

Research and development services

    2,878     4,505     1,627     56.5 %
                   

Total cost of revenue

  $ 26,675   $ 43,691   $ 17,016     63.8 %
                   

Gross profit (loss)

                         

Product

  $ (5,782 ) $ (2,548 ) $ 3,234     (55.9 )%

Research and development services

    1,041     1,779     738     70.9 %
                   

Total gross profit (loss)

  $ (4,741 ) $ (769 ) $ 3,972     (83.8 )%
                   

        Cost of Product Revenue.    The increase in cost of product revenue was primarily due to the increase in product revenue.

        Cost of Research and Development Services Revenues.    The increase in costs of research and development services revenue resulted from the increase in research and development services revenues.

        Product Gross Profit (Loss).    We experienced a product gross loss during the six months ended June 30, 2009, primarily due to low factory utilization. Our future gross profit will be affected by numerous factors, including the build-out of our manufacturing capacity and the timing of the production of new product designs. For example, unabsorbed manufacturing expenses were $11.5 million during the six months ended June 30, 2009. As a result, our gross profit or loss will vary significantly from period-to-period going forward.

        Research and Development Gross Profit.    Research and development gross profit increased due to the increase in research and development services revenue and the timing of project milestones.

Operating Expenses

 
  Six Months Ended
June 30,
  Change  
 
  2008   2009   $   %  
 
  (Dollars in thousands)
 

Operating expenses

                         

Research and development

  $ 15,094   $ 22,814   $ 7,720     51.1 %

Sales and marketing

    3,606     4,227     621     17.2 %

General and administrative

    8,831     12,452     3,621     41.0 %
                   

Total operating expenses

  $ 27,531   $ 39,493   $ 11,962     43.4 %
                   

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        Research and Development Expenses.    A portion of research and development expenses was offset by cost-sharing funding. Our research and development expenditures are summarized as follows:

 
  Six Months Ended
June 30,
  Change  
 
  2008   2009   $   %  
 
  (Dollars in thousands)
 

Research and development expenditures

                         

Aggregated research and development expenditures

  $ 17,845   $ 24,441   $ 6,596     37.0 %

Research and development reimbursements

    2,751     1,627     (1,124 )   (40.9 )%
                   

Research and development expenses

  $ 15,094   $ 22,814   $ 7,720     51.1 %
                   

        The increase in research and development expenses for the six months ended June 30, 2009 compared to the six months ended June 30, 2008 was primarily attributable to an increase of $3.7 million in personnel-related expenses associated with an increase in research and development personnel who primarily focus on manufacturing process improvement, material science chemistry and battery and battery systems technology, in addition to an increase in general product development and other research and development expenses of $4.0 million. Research and development expense as a percentage of revenue was 69% in the six months ended June 30, 2008, compared to 53% in the six months ended June 30, 2009.

        Sales and Marketing Expenses.    The increase in sales and marketing expenses for the six months ended June 30, 2009 compared to the six months ended June 30, 2008 was primarily attributable to an increase of $0.6 million in personnel-related expenses associated with an increase in sales and marketing personnel. In addition, marketing expenses related to trade shows, public relations, advertising and other sales and marketing related expenses increased by $0.1 million. Sales and marketing expense was 16% of revenue for the six months ended June 30, 2008, compared to 10% for the six months ended June 30, 2009.

        General and Administrative Expenses.    The increase from the six months ended June 30, 2008 to the six months ended June 30, 2009 was primarily due to an increase in personnel-related expenses of $1.4 million, professional fees of $2.1 million, and other general and administrative related expenses of $0.1 million. Professional fees were higher compared to the six months ended June 30, 2008 primarily due to legal and consulting fees associated with the application process of the Department of Energy's ATVM loan and grant programs. General and administrative expense was 40% of revenue for the six months ended June 30, 2008, compared to 29% for the six months ended June 30, 2009.

Other Income (Expense), Net

 
  Six Months Ended
June 30,
  Change  
 
  2008   2009   $   %  
 
  (Dollars in thousands)
 

Other income (expense), net

                         

Interest income

  $ 614   $ 62   $ (552 )   (89.9) %

Interest expense

    (407 )   (572 )   (165 )   40.5 %

Gain (loss) on foreign exchange

    76     (115 )   (191 )   N/M  

Unrealized loss on preferred stock warrant liability

    (759 )   (70 )   689     (90.8) %
                   

Total other income (expense), net

  $ (476 ) $ (695 ) $ (219 )   46.0 %
                   

        The decrease in interest income was primarily attributable to lower prevailing interest rates, which resulted in lower interest income for the six months ended June 30, 2009. The decrease in interest expense was primarily due to the timing of the repayment of certain obligations in the early part of the six months ended June 30, 2009. Additional borrowings occurred in the later part of that period. The increase in

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unrealized loss on preferred stock warrant liability was due to the increase in the fair market value of our stock.

        Provision for Income Taxes.    The provision for income taxes for the six months ended June 30, 2008 and 2009 was primarily related to foreign and state income taxes. We did not report a benefit for federal income taxes in the consolidated financial statements as the deferred tax asset generated from our net operating loss has been offset by a full valuation allowance because it is more likely than not that the tax benefits of the net operating loss carry forward may not be realized.

    Years Ended December 31, 2006 and 2007 and 2008

Revenue

 
  Years Ended December 31,   Change in 2007   Change in 2008  
 
  2006   2007   2008   $   %   $   %  
 
  (Dollars in thousands)
 

Product

                                           
 

Consumer

  $ 28,197   $ 32,908   $ 40,752   $ 4,711     16.7 % $ 7,844     23.8 %
 

Transportation

    149     2,596     9,862     2,447     N/M     7,266     279.9 %
 

Electric grid

            2,900         0.0 %   2,900     100.0 %
                               

Total Product

    28,346     35,504     53,514     7,158     25.3 %   18,010     50.7 %

Research and development services

    6,002     5,845     15,011     (157 )   (2.6 )%   9,166     156.8 %
                               

Total revenue

  $ 34,348   $ 41,349   $ 68,525   $ 7,001     20.4 % $ 27,176     65.7 %
                               

        Product Revenue.    The increase in product revenue in 2008 was due to increased sales of $7.3 million to customers in the transportation industry, increased sales of $5.1 million due to the inclusion of a full year of sales for Enerland, which we acquired in August 2007 and sales in the electric grid market of $2.9 million. Sales to other new and existing customers increased by $2.7 million.

        Subsequent to December 31, 2008, we terminated a supply agreement with Enerland's most significant customer due to non-payment. As a result, we expect revenues of small prismatic batteries to continue to decline and do not expect significant revenues from the sale of small prismatic batteries in the future.

        The increase in product revenue in 2007 was due to $3.6 million in sales by Enerland, which we acquired in August 2007, and the increase in sales to new customers of $3.6 million.

        Research and Development Services Revenue.    Revenue related to commercial projects increased by $11.3 million, which was partially offset by a $2.1 million decrease in revenue related to government agency research contracts. The increase in revenue from commercial projects was primarily related to new development arrangements with Chrysler and Mercedes-Benz HighPerformanceEngines. The decrease in government agency research contract revenue was due to the completion of projects during 2007 that were not replaced by new projects in 2008.

        In 2007 revenue related to government research contracts decreased by $2.0 million, but was partially offset by a $1.8 million increase in revenue related to commercial projects. The decrease in revenue from government research contracts was due to the completion of projects in 2007 that were not replaced by new projects in 2008. The increase in revenue from commercial projects resulted from entering into agreements with new customers during 2007.

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Cost of Revenue and Gross Profit (Loss)

 
  Years Ended December 31,   Change in 2007   Change in 2008  
 
  2006   2007   2008   $   %   $   %  
 
  (Dollars in thousands)
 

Cost of revenue

                                           

Product

  $ 28,960   $ 38,320   $ 70,474   $ 9,360     32.3 % $ 32,154     83.9 %

Research and development services

    4,417     4,499     10,295     82     1.9 %   5,796     128.8 %
                               

Total cost of revenue

  $ 33,377   $ 42,819   $ 80,769   $ 9,442     28.3 % $ 37,950     88.6 %
                               

Gross profit (loss)

                                           

Product

  $ (614 ) $ (2,816 ) $ (16,960 ) $ (2,202 )   N/M   $ (14,144 )   N/M  

Research and development services

    1,585     1,346     4,716     (239 )   N/M     3,370     N/M  
                               

Total gross profit (loss)

  $ 971   $ (1,470 ) $ (12,244 ) $ (2,441 )   N/M   $ (10,774 )   N/M  
                               

        Cost of Product Revenue.    The increase in cost of product revenue in 2008 was primarily due to a 50.7% increase in product revenue, which includes a $6.0 million increase resulting from the inclusion of a full year of sales by Enerland as compared to the sales from Enerland for only four months in 2007, an increase in unabsorbed manufacturing expenses of $10.5 million and $5.1 million of charges related to excess and obsolete inventory. We also incurred a $1.2 million expense for non-cancelable purchase orders associated with the bankruptcy of Think Global, one of our customers in the transportation industry.

        In 2007, the increase in cost of product revenue was primarily due to a 25.3% increase in product revenue and an increase in unabsorbed inventory overhead costs of $2.5 million due to new manufacturing facilities in China and Hopkinton, Massachusetts.

        Cost of Research and Development Services Revenue.    The increase in cost of research and development services revenue in 2008 resulted from the increase in research and development services revenues.

        Product Gross Profit (Loss).    We experienced a product gross loss during 2007 and 2008, primarily due to shifting away from a manufacturing model that was based substantially on the use of third-party contract manufacturers, and we continued to incur significant start-up costs from the opening of three manufacturing facilities in China and one in Hopkinton, Massachusetts in 2007. When new manufacturing facilities are opened, we incur significant start-up costs, which consist primarily of salaries and personnel-related costs and the cost of operating a new facility before it is operating at a full production level. In the long term, we expect the increase in our production will reduce the percentage of our cost of product revenue that is related to these unabsorbed manufacturing expenses. In 2006, we incurred a product gross loss since it was our first year of selling products and we did not have adequate revenues to cover our manufacturing costs.

        Research and Development Gross Profit.    During 2008, the increase in costs of research and development services revenue resulted from the increase in research and development services revenue and the timing of project milestones. During 2007, research and development gross profit decreased due to the timing of project milestones.

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Operating Expenses

 
  Years Ended December 31,   Change in 2007   Change in 2008  
 
  2006   2007   2008   $   %   $   %  
 
  (Dollars in thousands)
 

Operating expenses

                                           

Research and development

  $ 8,851   $ 13,241   $ 36,953   $ 4,390     49.6 % $ 23,712     179.1 %

Sales and marketing

    1,537     4,307     8,851     2,770     180.2 %   4,544     105.5 %

General and administrative

    6,129     13,336     21,544     7,207     117.6 %   8,208     61.5 %
                               

Total operating expenses

  $ 16,517   $ 30,884   $ 67,348   $ 14,367     87.0 % $ 36,464     118.1 %
                               

        Research and Development Expenses.    A portion of research and development expenses was offset by cost-sharing funding. Our research and development expenditures are summarized as follows:

 
  Years Ended December 31,   Change in 2007   Change in 2008  
 
  2006   2007   2008   $   %   $   %  
 
  (Dollars in thousands)
 

Research and development expenses

                                           

Aggregated research and development expenditures

  $ 8,885   $ 16,329   $ 41,778   $ 7,444     83.8 % $ 25,449     155.9 %

Research and development reimbursements

    34     3,088     4,825     3,054     N/M     1,737     56.3 %
                               

Research and development expenses

  $ 8,851   $ 13,241   $ 36,953   $ 4,390     49.6 % $ 23,712     179.1 %
                               

        The increase in research and development expenses in 2008 was primarily attributable to an increase of $9.1 million in personnel-related expenses associated with an increase in research and development personnel who primarily focus on manufacturing process improvement, material science chemistry and battery and battery systems technology, an increase in general product development expenses of $12.7 million, travel expenses of $0.8 million, other general research and development expenses of $0.7 million and a $0.4 million in-process research and development charge related to the acquisition of Enerland. Research and development expense as a percentage of revenue was 32% in 2007, compared to 54% in 2008. We expect research and development expenses to increase in absolute dollars as we continue to focus on developing new products and continuously improving the performance of existing products.

        The increase in research and development expenses in 2007 was primarily attributable to an increase of $4.7 million in personnel-related expenses associated with an increase in research and development personnel who primarily focus on manufacturing process improvement, material science chemistry and battery and battery systems technology, an increase in general product development expenses of $2.4 million and a $0.4 million in process research and development charge related to the acquisition of Enerland. Research and development expense as a percentage of revenue was 26% in 2006, compared to 32% in 2007.

        Sales and Marketing Expenses.    The increase in sales and marketing expenses in 2008 was primarily due to an increase of $1.6 million in personnel-related expenses associated with an increase in sales and marketing personnel. Marketing expenses related to trade shows, public relations, advertising and other sales and marketing related expenses increased by $1.1 million and travel expenses increased by $0.4 million in 2008. We also incurred a onetime $1.4 million expense related to the impairment of our Enerland customer relationships intangible asset. We expect sales and marketing expenses to increase in absolute dollars as we are planning on expanding our application support personnel and to open sales offices outside of North America. Sales and marketing expense as a percentage of revenue was 10% in 2007, compared to 13% in 2008.

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        The increase in sales and marketing expenses in 2007 was primarily attributable to an increase of $1.6 million in personnel-related expenses associated with an increase in sales and marketing personnel. In addition, marketing expenses related to trade shows and public relations increased by $0.5 million and travel expenses increased by $0.4 million. Sales and marketing expense as a percentage of revenue was 4% in 2006, compared to 10% in 2007.

        General and Administrative Expenses.    The increase in general and administrative expenses during 2008 was primarily due to an increase in personnel-related expenses of $2.7 million, a payment of $1.3 million related to a termination agreement with a customer, travel expenses of $0.4 million, bad debt expense of $1.3 million primarily related to Enerland, and other general and administrative related expenses of $2.8 million. These amounts were partially offset by a decrease of $0.3 million in professional fees. We expect our general and administrative expenses to further increase as we incur additional expenses associated with being a publicly-traded company, including costs of comprehensively analyzing, documenting and testing our systems of internal controls and maintaining our disclosure controls and procedures in preparation for the regulatory requirements of the Sarbanes-Oxley Act, increased professional services fees, higher insurance costs, additional costs associated with general corporate governance and the hiring of additional personnel in connection with the remediation of our material weaknesses. General and administrative expense as a percentage of revenue was 32% in 2007, compared to 31% in 2008.

        The increase in general and administrative expenses during 2007 was primarily due to an increase in professional fees of $4.3 million and an increase in personnel-related expenses of $2.5 million. Professional fees were higher in 2007 in anticipation of becoming a publicly-traded company. In addition, we incurred expenses to present Enerland's prior financial statements in accordance with U.S. GAAP. General and administrative expense as a percentage of revenue was 18% in 2006, compared to 32% in 2007.

Other Income (Expense), Net

 
  Years Ended December 31,   Change in 2007   Change in 2008  
 
  2006   2007   2008   $   %   $   %  
 
  (Dollars in thousands)
 

Other income (expense), net

                                           

Interest income

  $ 871   $ 1,729   $ 1,258   $ 858     98.5 % $ (471 )   (27.2 )%

Interest expense

    (641 )   (716 )   (812 )   (75 )   11.7 %   (96 )   13.4 %

Gain (loss) on foreign exchange

        502     (724 )   502     N/M     (1,226 )   N/M  

Unrealized loss on preferred stock warrant liability

    (362 )   (57 )   (286 )   305     (84.3 )%   (229 )   N/M  
                               

Total other income (expense), net

  $ (132 ) $ 1,458   $ (564 ) $ 1,590     N/M   $ (2,022 )   N/M  
                               

        The decrease in other income (expense), net in 2008 was primarily due to a loss of $1.2 million in foreign exchange and a decrease in interest income of $0.5 million resulting from lower prevailing interest rates.

        The increase in other income (expense), net in 2007 was primarily due to an increase in interest income of $0.9 million, and an increase of $0.5 million in foreign currency related gains and a decrease in unrealized loss on changes in the fair value of preferred stock warrants of $0.3 million. The increase in interest income is primarily attributable to higher average cash balances, which resulted in higher interest income in 2007. The increase in interest expense is due to an increase in the average borrowing balances, which resulted in higher interest expense.

        Provision for Income Taxes.    The provision related to foreign and state income taxes. We did not report a benefit for federal income taxes in the consolidated financial statements as the deferred tax asset generated from our net operating loss has been offset by a full valuation allowance because it is more likely than not that the tax benefits of the net operating loss carryforward may not be realized.

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Liquidity and Capital Resources

    Sources of Liquidity

        Since inception, we have funded our operations primarily through private placements of preferred stock, common stock, convertible promissory notes, demand notes, term loans, revolving credit facilities and other credit facilities. Through June 30, 2009, these financings have provided us with aggregate net proceeds of approximately $383.0 million. During the six months ended June 30, 2009, we received $99.9 million from the issuance of 10.9 million shares of series F convertible preferred stock. As of June 30, 2009, we had cash and cash equivalents of $114.9 million and accounts receivable of $15.8 million.

        We believe that our available cash and cash equivalents and net proceeds from this offering will be sufficient to fund our operations through 2010. In addition, we believe that our available cash and cash equivalents will provide sufficient capital to fund our anticipated customer demand through 2010. We make investments in manufacturing capacity 12-15 months prior to the time we need it to meet customer demand. If customer demand exceeds our current plans, we will need to raise additional capital sooner than planned. This may require us to access additional capital through equity or debt offerings. We have also applied for various State and Federal loan and grant programs, and in August 2009, the U.S. government announced that we have been selected to receive a $249.1 million grant under the DOE Battery Initiative to support our manufacturing expansion. We have also applied for direct loans under the ATVM Program, to support this manufacturing expansion. Based on the amount of our grant award under the DOE Battery Initiative and the guidelines associated with the ATVM Program, we believe we will be permitted to borrow up to $235 million under the ATVM Program. Under the DOE Battery Initiative, we will be required to spend up to one dollar of our own funds for every incentive dollar we receive, and we expect we will be required to spend one dollar of our own funds for every four dollars we borrow under the ATVM Program. The timing and the amount of any loan we may receive under the ATVM Program, as well as the specific terms and conditions applicable to our grant award under the DOE Battery Initiative or any loan we may receive, are currently not known by us, and, once disclosed to us, are subject to change and negotiation with the federal government. Access to these funds could offset some of our future capital needs. The future capital requirements that may be required to support expanded manufacturing capacity, product testing capabilities, and working capital could be significant over the next several years. If we are unable to access additional capital, our growth will be limited due to the inability to invest in additional manufacturing capacity.

    Capital Expenditures

        Our capital expenditures were $6.9 million in 2006, $15.0 million in 2007, $41.4 million in 2008 and $17.2 million for the six months ended June 30, 2009. We estimate our total capital expenditures for the remaining six months of 2009 to be approximately $34.2 million, which will primarily relate to the expansion of our current facilities. In 2010 and beyond, we expect to use a significant portion of our cash for capital expenditures to increase manufacturing capacity in anticipation of increased demand for our products.

    Cash Flows

        The following table sets forth the major sources and uses of cash for each of the periods set forth below:

 
  Years Ended December 31,   Six Months Ended
June 30,
 
 
  2006   2007   2008   2008   2009  
 
  (in thousands)
 

Net cash used in operating activities

  $ 18,941   $ 28,897   $ 34,945   $ 23,537   $ 42,774  

Net cash used in investing activities

    10,178     27,244     41,088     12,684     19,452  

Net cash provided by financing activities

    32,596     70,034     123,018     117,285     106,517  

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        Cash Flows from Operating Activities.    Operating activities used $42.8 million of net cash during the six months ended June 30, 2009. We incurred a net loss of $41.2 million in the six months ended June 30, 2009, which included non-cash share-based compensation expense of $4.0 million and depreciation and amortization of $6.3 million. Changes in asset and liability accounts used $12.0 million of net cash during the six months ended June 30, 2009.

        Operating activities used $34.9 million of net cash during the year ended December 31, 2008. We incurred a net loss of $80.4 million in the year ended December 31, 2008, which included non-cash share-based compensation expense of $4.5 million, an impairment of long-lived assets and intangibles of $3.1 million, and depreciation and amortization of $8.2 million. Changes in assets and liability accounts generated $28.2 million of net cash during the year ended December 31, 2008, primarily due to $25.0 million in deferred revenue we received from Gillette.

        Operating activities used $28.9 million of net cash during the year ended December 31, 2007. We incurred a net loss of $31.0 million in 2007, which included non-cash share-based compensation expense of $1.6 million and depreciation and amortization of $3.9 million. Changes in assets and liabilities used $3.9 million of net cash during the year ended December 31, 2007.

        Operating activities used $18.9 million of net cash during the year ended December 31, 2006. We incurred a net loss of $15.8 million, which included non-cash share-based compensation expense of $1.0 million, and non-cash depreciation and amortization of $2.7 million. Changes in assets and liabilities used $7.5 million of net cash during the year ended December 31, 2006.

        We expect our cash flows from operations to remain negative for the foreseeable future primarily as a result of our net losses and working capital needs.

        Cash Flows from Investing Activities.    Cash flows from investing activities primarily relate to capital expenditures to support our growth.

        Cash used in investing activities totaled $19.5 million during the six months ended June 30, 2009 and consisted of capital expenditures of $17.2 million primarily related to the purchase of manufacturing equipment and an increase in restricted cash of $2.2 million.

        Cash used in investing activities totaled $41.1 million during the year ended December 31, 2008 and consisted of capital expenditures of $41.4 million primarily related to the purchase of manufacturing equipment and an increase in restricted cash used of $0.2 million. These expenditures were partially offset by the proceeds from disposal of equipment of $0.5 million.

        Cash used in investing activities totaled $27.2 million during the year ended December 31, 2007 and consisted of capital expenditures of $15.0 million, primarily related to the purchase of manufacturing equipment, a decrease in restricted cash that generated $1.2 million of cash, $13.4 million of cash used, net of cash acquired, for the acquisition of Enerland and $0.1 million of cash used, net of cash acquired, for the purchase of Hymotion assets.

        Cash used in investing activities totaled $10.2 million during the year ended December 31, 2006 and consisted of capital expenditures of $6.9 million, the purchase of T/J Technologies of $1.6 million, the issuance of a note receivable of $1.0 million, and an increase in restricted cash of $1.2 million. These uses were offset by the repayment of the notes receivable of $0.5 million.

        We anticipate higher capital expenditure levels in future periods as we continue to fund the expansion of our facilities to support the anticipated growth of our business.

        Cash Flows from Financing Activities.    Cash flows from financing activities totaled $106.5 million during the six months ended June 30, 2009 and included proceeds of $99.6 million from the issuance of series F convertible preferred stock, proceeds from government grants of $3.0 million and proceeds from issuance of long-term debt of $7.6 million. These proceeds were partially offset by repayments on long-term debt of

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$2.6 million and $0.8 million of deferred offering costs. In 2009, we expect financing activities such as equity offerings and debt issuances to be a significant source of cash.

        Cash flows from financing activities totaled $123.0 million during the year ended December 31, 2008 and included proceeds of $102.0 million from the issuance of series E convertible preferred stock, $11.5 million from the issuance of redeemable common stock, proceeds of $5.0 million from the issuance of common stock, $9.1 million in proceeds from the issuance of long-term debt and $4.3 million from advances under credit lines. These proceeds were partially offset by repayments on long-term debt of $4.0 million and deferred offering costs of $3.8 million.

        Cash flows from financing activities totaled $70.0 million during the year ended December 31, 2007 and included proceeds of $69.9 million from the issuance of series D convertible preferred stock, proceeds of $1.0 million from the issuance of common stock and exercise of stock options and $2.7 million from advances under credit lines. These proceeds were offset by repayments on long-term debt and capital lease obligations of $3.6 million.

        Cash flows from financing activities totaled $32.6 million during the year ended December 31, 2006 and included proceeds of $30.3 million from the issuance of series C convertible preferred stock, proceeds from the issuance of long-term debt and a letter of credit of $3.6 million. These proceeds were partially offset by the repayment of $1.3 million on long-term debt.

    Credit Facilities

        As of June 30, 2009, the following credit facilities were outstanding:

Lender
  Date   Type of
Facility
  Interest
Rate (per
annum)
  Principal
Amount
  Amount
Outstanding
  Maturity
Date

Silicon Valley Bank/Gold Hill

  November 2006   Term Loan   10.75%     2,000,000     317,000   November 2009

Silicon Valley Bank/Gold Hill

  December 2006   Term Loan   10.75%     1,000,000     189,000   December 2009

Silicon Valley Bank

  September 2008   Term Loan   Prime +0.75%     7,500,000     6,667,000   January 2012

Silicon Valley Bank

  April 2009   Term Loan   Prime +0.75%     2,500,000     2,500,000   July 2012

Silicon Valley Bank

  May 2009   Term Loan   Prime +0.75%     3,000,000     3,000,000   August 2012

Silicon Valley Bank

  June 2009   Term Loan   4.75%     1,000,000     1,000,000   September 2012

Silicon Valley Bank

  September 2008   Operating Line of Credit   Prime     8,000,000     8,000,000   September 2010

Note Payable

  April 2009   Promissory Note   4%     830,000     830,000   December 2009

Industrial Bank of Korea

  March 2008   Term Loan   Variable     1,170,000     1,169,000   February 2010

Korean Government

  Various   Refundable Grant   0%     447,000     449,000   Milestone-based

Small Business Corporation

  August 2006   Term Loan   Variable     156,000     117,000   August 2011

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    Contractual Obligations

        The following is a summary of our contractual obligations as of June 30, 2009:

 
   
  Payments Due in  
 
  Total   Less than
1 Year
  1-3 Years   3-5 Years   More than
5 Years
 
 
  (in thousands)
 

Long-term debt, including current portion

  $ 16,238   $ 7,058   $ 8,658   $ 319   $ 203  

Capital lease obligations

    830     568     181     81      

Operating lease obligations

    18,176     2,646     4,829     3,062     7,639  

Purchase obligations(1)

    18,157     18,157              
                       
 

Total

  $ 53,401   $ 28,429   $ 13,668   $ 3,462   $ 7,842  
                       

(1)
Purchase obligations include agreements or purchase orders to purchase goods or services that are enforceable and legally binding and specify all significant terms. Purchase obligations exclude agreements that are cancelable without penalty.

        In addition to the above, as discussed in Note 12 to our consolidated financial statements, we have approximately $0.7 million associated with uncertain tax positions and related interest and penalties. These liabilities are included as a component of "other long-term liabilities" in our consolidated balance sheet, as we do not anticipate that settlement of the liabilities will require payment of cash within the next twelve months. We are not able to reasonably estimate when we would make any cash payments required to settle these liabilities, but do not believe that the ultimate settlement of our obligations will materially affect our liquidity. Additionally, we have a line of credit with an outstanding balance of $8.0 million as of June 30, 2009.

    Off-Balance Sheet Arrangements

        We did not have during the periods presented, and we do not currently have, any off-balance sheet arrangements, as defined under SEC rules, such as relationships with unconsolidated entities or financial partnerships, which are often referred to as structured finance or special purpose entities, established for the purpose of facilitating financing transactions that are not required to be reflected on our balance sheet.

Quantitative and Qualitative Disclosures About Market Risk

    Interest Rate Risk

        We had cash and cash equivalents totaling $114.9 million as of June 30, 2009, and $70.5 million, $23.4 million and $9.5 million as of December 31, 2008, 2007, and 2006, respectively. Our exposure to interest rate risk primarily relates to the interest income generated by excess cash invested in highly liquid investments with maturities of three months or less from the original dates of purchase. The cash and cash equivalents are held for working capital purposes. We have not used derivative financial instruments in our investment portfolio. We have not been exposed, nor do we anticipate being exposed, to material risks due to changes in market interest rates. Declines in interest rates, however, will reduce future investment income. If overall interest rates had declined by 100 basis points during the six months ended June 30, 2009 and the year ended December 31, 2008, our interest income would have decreased by approximately $0.4 million and $0.6 million, respectively, assuming consistent investment levels.

        Interest rate risk also refers to our exposure to movements in interest rates associated with our interest bearing liabilities. The interest bearing liabilities are denominated in U.S. dollars and the interest expense is based on the prime interest rate plus an additional margin, depending on the respective lending institutions. If the prime rate had increased by 100 basis points during the six months ended June 30, 2009 and the year ended December 31, 2008, our interest expense would have increased by approximately $0.1 million, assuming consistent borrowing levels.

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    Foreign Currency Risk

        As a result of our foreign operations, we have significant expenses, assets and liabilities that are denominated in foreign currencies. A significant number of our employees are located in Asia. Therefore, a substantial portion of our payroll as well as certain other operating expenses are paid in the China RMB and South Korean Won. Additionally, we purchase materials and components from suppliers in Asia. While we pay these suppliers in U.S. dollars, their costs are typically based upon the local currency of the country in which they operate. All of our revenues are received in U.S. dollars because our customer contracts generally provide that our customers will pay us in U.S. dollars.

        As a consequence, our gross profit, operating results, profitability and cash flows are adversely impacted when the dollar depreciates relative to other foreign currencies. We have a particularly significant currency rate exposure to changes in the exchange rate between the RMB and the U.S. dollar. For example, to the extent that we need to convert U.S. dollars we receive from this offering into RMB for our operations, appreciation of the RMB against the U.S. dollar would have an adverse effect on the RMB amount we receive from the conversion. We have not used any forward contracts or currency borrowings to hedge our exposure to foreign currency exchange risk.

Recent Accounting Pronouncements

        In May 2009, the FASB issued FASB Statement No. 165, Subsequent Events. This statement establishes the general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued. In addition, this statement requires disclosure of the date through which an entity has evaluated subsequent events and the basis for that date. We adopted FASB Statement No. 165 for the quarterly period ending June 30, 2009. The adoption of FASB Statement No. 165 did not have a material impact on our financial statements. Please see Note 20 to our consolidated financial statements for information regarding the adoption of this standard.

        In December 2007, the FASB issued Statement No. 141(R), Business Combinations, which revises FASB Statement No. 141, Business Combinations. FASB Statement No. 141(R) establishes principles and requirements for how the acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed and any non-controlling interest in the acquired entity and the goodwill acquired. FASB Statement No. 141(R) also establishes disclosure requirements which will enable users to evaluate the nature and financial effects of business combinations.

        In December 2007, the FASB issued FASB Statement No. 160, Noncontrolling Interest in Consolidated Financial Statements—an amendment of Accounting Research Bulletin No. 51, which establishes accounting and reporting standards for ownership interests in subsidiaries held by parties other than the parent, the amount of consolidated net income attributable to the parent and to the noncontrolling interest, changes to a parent's ownership interest and the valuation of retained noncontrolling equity investments when a subsidiary is deconsolidated. The Statement also establishes reporting requirements that provide sufficient disclosures that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. FASB Statement No. 160 is effective for fiscal years beginning after December 15, 2008. We adopted FASB Statement No. 160 on January 1, 2009. The presentation and disclosure requirements have been applied retrospectively for all periods.

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BUSINESS

Overview

        We design, develop, manufacture and sell advanced, rechargeable lithium-ion batteries and battery systems. Our batteries and battery systems provide a combination of power, safety and life that we believe no other commercially available battery provides. We believe that lithium-ion batteries will play an increasingly important role in facilitating a shift toward cleaner forms of energy. Using our innovative approach to materials science and battery engineering and our systems integration and manufacturing capabilities, we have developed a broad family of high-power lithium-ion batteries and battery systems. This family of products, combined with our strategic partner relationships in the transportation, electric grid services and consumer markets, positions us well to address these markets for next-generation energy storage solutions.

        In our largest target market, the transportation industry, we are working with major global automotive manufacturers and tier 1 suppliers to develop batteries and battery systems for HEVs, PHEVs and EVs. For example, we are designing and developing batteries and battery systems for BMW, Chrysler, GM, SAIC, Delphi and Better Place for multiple passenger vehicle models. Based on data from IHS Global Insight, we estimate that the number of HEV, PHEV and EV models with an annual production run of at least 20,000 vehicles will grow from 19 models in 2009 to over 150 models in 2014 and over 200 models in 2019. According to A.T. Kearney, the global lithium-ion battery market for automotive application in HEVs, PHEVs, and EVs is estimated to be $31.9 million in 2009. A.T. Kearney projects that this market will grow to approximately $21.8 billion by 2015 and $74.1 billion by 2020, based on a moderate drive for change influenced by increasing governmental regulation, emerging powertrain technology, changing consumer demand, and OEM product strategies toward more fuel efficient vehicles.

        We are also implementing our battery technology for use in heavy-duty vehicles. We are engaged in design and development activities with five heavy-duty vehicle manufacturers and tier 1 suppliers regarding their HEV and EV development efforts for trucks and buses, and we have been selected to co-develop battery systems for several of them. For example, pursuant to our supply agreement with Magna Steyr, we are providing batteries for use in battery systems developed by Magna Steyr for deployment in the Volvo 7700 Hybrid bus. In addition, we have a development and supply agreement with BAE Systems, pursuant to which we are in volume production for battery systems for BAE Systems' Hybridrive propulsion system, which is currently being deployed in Daimler's Orion VII hybrid electric buses. We also have been selected to develop the battery system for an additional Daimler hybrid electric bus program.

        In addition to the development activities described above, we are bidding for programs with several other vehicle manufacturers to develop and/or supply batteries and battery systems for HEVs, PHEVs and EVs.

        Our cylindrical batteries are in volume production and are commercially available for use in automotive and heavy duty vehicles. Our next generation cylindrical batteries and our prismatic batteries are either in development or in prototype production and testing and have not yet been deployed by passenger vehicle manufacturers in commercial production vehicles. Our batteries for the transportation market have been commercially deployed in our Hymotion L5 battery range extender module and in both the Daimler Orion VII and Volvo 7700 hybrid buses.

        We are also developing battery systems that we believe will improve the reliability of the electric power grid. We are working with AES to engineer, manufacture and install multi-megawatt battery systems, called Hybrid-APUs, that provide electric and ancillary services such as standby reserve capacity and frequency regulation services. Our products provide standby reserve capacity, by delivering power quickly in order to offset supply shortages caused by generator or transmission outages, and frequency regulation, by regulating the minute-to-minute frequency fluctuations in the grid that are caused by changes in supply and demand. The first of the AES systems, a two megawatt system housed in a 53-foot trailer, is installed at an AES facility, and we have shipped additional units for AES, totaling 16 megawatts.

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        We are also focusing on the consumer market. We first commercialized our battery technologies for use in cordless power tools. Since 2006, we have supplied batteries to Black & Decker, a leading producer of power tools. Our batteries are used in Black & Decker's 36, 18, and 14.4 volt power tool lines. We also have agreements with The Gillette Company, a wholly-owned subsidiary of The Procter & Gamble Company, to supply Gillette with materials and technology for use in their consumer products.

        In the first half of 2009, 70% of our product revenue was derived from sales in the transportation market and 30% was derived from sales in the consumer market.

        Our proprietary technology includes nanoscale materials initially developed at and exclusively licensed from the Massachusetts Institute of Technology. We are developing new generations of this core nanophosphate technology, as well as other battery technologies, to achieve additional performance improvements and to expand the range of applications for our batteries. For example, we recently developed an ultra high power battery for Mercedes-Benz HighPerformanceEngines for use by the Vodafone McLaren Mercedes team that provides more than ten times the W/kg as compared to a standard Prius battery. Our research and development team comprises over 215 employees and has significant expertise in battery materials science, process engineering and battery-package engineering, as well as battery system design and integration. We own or exclusively license 45 issued patents and more than 200 pending patents in the United States and internationally.

        We intend to take advantage of U.S. government programs established to stimulate the economy and increase domestic investment in the battery industry. In February 2009, the U.S. government approved a stimulus program under the ARRA, which includes $2 billion of grants under the DOE Battery Initiative for the development of advanced batteries and electric drive components. In August 2009, the U.S. government announced that we have been selected to receive a $249.1 million grant award under the DOE Battery Initiative to fund the construction of new lithium-ion battery manufacturing facilities in Michigan. We have also applied for direct loans under the DOE ATVM Program, to support this manufacturing expansion. Based on the amount of our grant award under the DOE Battery Initiative and the guidelines associated with the ATVM Program, we believe we will be permitted to borrow up to $235 million under the ATVM Program. Under the DOE Battery Initiative, we will be required to spend up to one dollar of our own funds for every incentive dollar we receive, and we expect we will be required to spend one dollar of our own funds for every four dollars we borrow under the ATVM Program. The timing and the amount of any loan we may receive under the ATVM Program, as well as the specific terms and conditions applicable to our grant award under the DOE Battery Initiative or any loan we may receive, are currently not known by us, and, once disclosed to us, are subject to change and negotiation with the federal government.

        The State of Michigan has awarded us a $10 million grant and offered us up to $4 million in low interest loans as an incentive to establish a lithium-ion battery manufacturing plant. We have received $3 million of the $10 million grant, with the remainder to be paid based on the achievement of certain milestones in our facility development. We intend to use these funds to support our planned expansion in Livonia, Michigan. In addition, in April 2009, MEGA granted us a credit for 50% of our capital investment expenses, up to a maximum of $100 million over a four-year period, related to the construction of an integrated battery cell manufacturing plant, which we intend to build if we receive adequate funds from the DOE. We must create at least 300 jobs at the plant in order to receive this credit. MEGA has also offered us a 15-year tax credit, beginning with the 2011 fiscal year, having an estimated value of up to $25.3 million, depending on the number of jobs we create in Michigan.

        We perform most of our manufacturing at our facilities using our proprietary, high-volume process technologies. Our internal manufacturing operations allow us to directly control product quality and minimize the risks associated with disclosing proprietary technology to outside parties during production. We control every stage in the manufacture of our products except for the final assembly of one battery model and certain battery systems. Over the past several years, we have developed high-volume production expertise and replicable manufacturing processes that we believe we can scale to meet increasing demands

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for our products. Our manufacturing processes can be modified to manufacture battery products for different applications and can be replicated to meet increasing customer demands. As of June 30, 2009, our annual manufacturing capacity was approximately 169.3 million watt hours. We have over 450,000 square feet of manufacturing facilities in China, Korea, Livonia, Michigan and Hopkinton, Massachusetts where we produce or intend to produce batteries and battery systems. If we receive sufficient federal and state incentive funding, we plan to expand our domestic battery manufacturing capacity. This expansion would complement our existing manufacturing facilities in Asia.

        We were incorporated in 2001. We were founded by Yet-Ming Chiang, Gilbert N. Riley, Jr. and Ric Fulop in order to commercialize new battery technology developed in Dr. Chiang's laboratory at the Massachusetts Institute of Technology. We began selling our first products commercially in the first quarter of 2006. We have approximately 1,700 employees worldwide. Since inception through June 30, 2009, we have generated $188.2 million in revenue consisting of $154.0 million in product revenue and $34.2 million in research and development revenue. Since inception through June 30, 2009, we have shipped 124.6 million Wh. Our revenue has grown from $34.3 million for the year ended December 31, 2006 to $41.3 million for the year ended December 31, 2007 to $68.5 million for the year ended December 31, 2008 and from $21.9 million for the six months ended June 30, 2008 to $42.9 million for the six months ended June 30, 2009.

Industry Background

        The world economy is undergoing a transformation driven by rising demands for high-output, fuel-efficient energy solutions that are less harmful to the environment. Global economic growth, geo-political conflict in oil-producing regions and escalating exploration and production costs are increasing market demand for innovative energy alternatives that can help reduce dependence on oil. Meanwhile, heightened concerns about global warming and climate change are giving rise to stricter environmental standards and stronger regulatory support for energy sources that are not harmful to the environment. As a result, clean energy technologies are experiencing increasing popularity and greater adoption which is fueling continued innovation and improving the economic viability of such technologies. We believe these clean energy trends are contributing to a growing demand for advanced battery technologies in end markets such as transportation, electric grid services and consumer.

    Transportation

        According to A.T. Kearney, the global lithium-ion battery market for automotive application in HEVs, PHEVs, and EVs is estimated to be $31.9 million in 2009. A.T. Kearney projects that this market will grow to approximately $21.8 billion by 2015 and $74.1 billion by 2020, based on a moderate drive for change influenced by increasing governmental regulation, emerging powertrain technology, changing consumer demand, and OEM product strategies toward more fuel efficient vehicles. We believe this growth will be driven by a fundamental shift away from conventional gasoline engines to HEVs, PHEVs and EVs. Consumer appeal, stemming from the high prices of conventional fuel, greater awareness of environmental issues and government regulation, is increasing the demand for HEVs, PHEVs and EVs. These vehicles offer improved gas mileage and reduced carbon emissions, and may ultimately provide a vehicle alternative that eliminates the need for conventional gasoline engines. Industry experts project that by 2020, almost half of U.S. vehicles will require some form of battery technology to meet new Corporate Average Fuel Economy, or CAFÉ, regulatory standards. President Obama recently announced new national standards to cut emissions and increase gas mileage, mandating that U.S. passenger vehicles and light trucks must average 35.5 miles per gallon by 2016. In addition, governments continue to implement economic incentives related to fuel efficiency. For example, in February 2009, the U.S. government enacted ARRA, which, among other things, provides for a tax credit of between $2,500 and $7,500 for the purchase of plug-in electric vehicles depending on the battery capacity, and the Department of Energy announced a $300 million grant program to provide funding for cost-shared projects that expand the use of alternate

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fueled vehicles and advanced technology vehicles, including the installation of after-market equipment necessary to support them.

        On a cost per mile driven basis, electricity is on average a more economical source of energy than gasoline. However, electricity has not been the most economic energy source for vehicle powertrains due to the cost, power and energy storage limitations of the conventional battery technologies used to deliver the electric power. With the advancement of battery technologies, the use of battery systems to deliver energy to hybrid powertrains is becoming more economically viable. We believe this trend will lead to increased adoption of HEVs, PHEVs and EVs and, as a result, create significant opportunities for battery suppliers with the necessary technology, experience and manufacturing capabilities to develop high performance batteries. We expect that if consumers begin realizing more immediate cost savings by switching away from gasoline powered vehicles to hybrid vehicles, the resulting increased adoption of HEVs, PHEVs and EVs will significantly contribute to the growth of the next-generation battery market.

        Similar industry dynamics are creating a demand for new battery technology applications in the heavy-duty transportation market, particularly in buses, trucks and other industrial vehicles. The higher fuel consumption rate of these large vehicles makes the potential fuel cost savings derived from the use of batteries even greater. Several government authorities and corporations are evaluating battery technologies for their large fleets of heavy-duty vehicles. For example, the City of London has announced plans to convert its fleet of buses to HEVs, with a goal that by 2012 all new buses entering the fleet will be HEVs.

    Electric Grid Services

        Applications in the electric grid market present another significant opportunity for the use of advanced battery systems. Performance and reliability are essential to electric transmission and distribution grids. To preserve electric grid integrity, grid operators often need to call on resources to provide critical ancillary services such as standby reserve capacity and frequency regulation services. Resources required for standby reserve capacity services must ramp up and down quickly to offset sudden, short-term generator or transmission line outages. Resources for frequency regulation services are called upon to adjust for minute-to-minute frequency fluctuations in the grid due to demand and supply changes. Traditionally, these grid services are provided by running select power plants on the grid below their full load capability so they can be called on and ramped up quickly as needed. Advanced batteries capable of providing rapid charge and discharge cycles as well as high power over a long period may cost effectively provide standby reserve capacity and frequency regulation services. Through the use of batteries, the portion of power plant capacity normally reserved for ancillary services to provide standby reserve capacity and frequency regulation can be freed up to operate at full capacity and produce more electricity and associated revenue.

        We believe the escalating demand for renewable energy technologies will serve as an additional catalyst for the adoption of advanced batteries in electric grid applications. Wind and solar energy facilities are expected to be important sources of new electricity generation in the future. However, wind and solar are intermittent power sources that are often not well suited to support the grid and put additional demands on grid stabilization. Advanced batteries can be used to supplement these new generation technologies by providing regulation services and excess energy storage during periods of high transmission line usage or low customer demand.

        The ARRA provides for $4.5 billion in direct spending on the U.S. electric grid, including funds to modernize the grid with so-called "Smart Grid" technologies, which are intended to stimulate investment by utilities in a smarter, more efficient grid and cleaner, renewable electricity generation technology. Emerging Smart Grid practices and technologies, such as the deployment and integration of advanced energy storage technologies, are designed to modernize the electric power grid. We believe utility companies that benefit from the ARRA's Smart Grid initiative will increase spending on advanced batteries and battery systems.

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    Consumer

        Consumer applications represent another attractive market for advanced batteries. There are two types of batteries for consumer applications: high-energy batteries and high-power batteries. High-energy batteries are designed to store large amounts of energy for long periods, but are not required to release this energy at a high rate. These batteries are used in certain portable consumer electronics such as laptop computers, PDAs and cell phones, which require gradual, consistent delivery of energy in low-power form. High-power batteries, on the other hand, are designed not only to store large amounts of energy, but also to deliver it at a very high rate, or in high-power form. While the battery market for high energy, low-power portable consumer products is mature and well supplied by several vendors, a market opportunity exists for advanced batteries that can deliver high-power in a light-weight and portable package.

        High-power batteries can transform appliances, tools and equipment traditionally powered from electric outlets into more convenient, portable devices. These batteries are currently being used in cordless power tools and portable medical devices, with additional potential applications in home appliances and commercial cleaning equipment. Consumers in these initial applications continue to demand high-power batteries for portable applications that are smaller, lighter and longer lasting than those currently used. In addition, with escalating environmental concerns around battery disposal, the market is also increasingly focused on replacing the battery technologies which utilize toxic metals such as nickel or lead. High-power batteries may also replace small internal combustion engines that power widely available lawn and garden equipment such as hedge trimmers or lawn mowers, possibly providing size and weight advantages, eliminating the need for expensive fuel, reducing hydrocarbon emissions and reducing noise.

    Challenges in Battery and Battery System Design

        The performance and specific characteristics of rechargeable batteries depend on the properties of their materials, the design of the batteries and the battery systems and the manufacturing process. Providers of rechargeable batteries face a number of challenges in addressing the requirements of transportation, electric grid services and consumer applications:

    Delivery of sufficient power for target applications.  A battery must be able to deliver the electrical power required by the application. Electrical power, measured in watts, is the rate at which electrical energy is delivered. Having adequate power is particularly important in applications such as EVs, where acceleration is an essential component of performance.

    Ability to operate for sufficient duration between charges.  A battery can provide a certain total amount of electrical energy to the application. Energy is the product of power and time, measured in watt hours. Batteries with higher energy can function for longer periods when used at a certain power than those of lower energy. Thus, in PHEV and EV applications, the energy of the battery determines the automobile's mileage range while it is running only on electricity.

    Delivery of sufficient energy at high power.  The total energy that a battery can deliver also depends on the power requirements of the application being addressed. When a battery is used at higher power, the usable energy of the battery is less than it is at lower power. Battery types vary widely in the amount of energy that can be delivered when the battery is used at high power.

    Ability to operate safely.  Safety is a primary concern for batteries used in consumer products and automobiles. For example, battery types differ in their susceptibility to thermal runaway, which is the internal generation of significant heat leading to battery damage and potential combustion.

    Sufficient cycle and calendar life.  The cycle life of a battery is the number of times it can be recharged without significantly reducing its ability to accept a charge. The calendar life is the total time in service before the battery can no longer deliver the energy or power required by the application.

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    Ability to be rapidly charged.  Batteries differ in the time required to charge before use. For example, HEVs require a battery that can be charged quickly in order to take advantage of the energy savings provided by regenerative braking.

    Minimizing size and weight while delivering sufficient power and energy.  Size and weight are critical considerations for many battery applications, including automobiles and power tools. For a specific application, batteries with higher energy and power per unit of size and weight can be made smaller and lighter. This is especially important for portable and transportation applications.

    Maintenance of charge when stored.  All batteries experience some self discharge, which is a slow loss of energy from the battery during storage. The rate of self discharge may be affected by battery chemistry, battery design or manufacturing quality. Self discharge tends to occur more rapidly when batteries are stored at high temperatures.

    Power and energy degradation over life.  Batteries will lose some of their ability to deliver power and store energy throughout their normal usage life. The degradation typically increases with repeated charge and discharge and if the battery is exposed to high temperatures. The rate of power and energy degradation can determine the cycle life or calendar life of the battery.

    Delivering maximum performance for the lowest cost.  Batteries are typically evaluated based on their performance in relation to their cost. The cost of raw materials and components and the battery's design are key factors affecting this evaluation. Other attributes such as manufacturing efficiency, battery system design and electronic control circuitry can also impact a battery system's cost.

    Availability of raw materials.  For applications such as transportation and electric grid services, if widespread adoption occurs, the large expected volume will require batteries based on raw materials that are in abundant, readily available supply.

    Requirements for environmentally-friendly disposal.  Nickel-cadmium and lead-acid rechargeable batteries contain toxic metals that raise environmental concerns in disposal. Consumer awareness and government regulations are contributing to the need for rechargeable batteries that contain materials that can be disposed of with the least harmful impact on the environment.

        The most prevalent battery technologies currently available that address the transportation, electric grid services or consumer markets include:

    Lead-acid batteries.  Lead acid is one of the oldest and most developed battery technologies. It is an inexpensive and popular storage choice that is generally reliable and relatively simple to manufacture. Most automobile manufacturers use lead acid in automotive starter batteries. Lead-acid batteries have also traditionally been used in electric grid services applications. However, lead-acid batteries are heavier per unit of stored energy than some other battery technologies and are therefore not practical for use in many consumer applications. They also have long charge times and low power output for their mass. In addition, lead can be hazardous to the environment.

    Nickel-based batteries.  Nickel-based batteries come in two main forms: nickel cadmium, or NiCd, and nickel metal hydride, or NiMH. NiCd batteries are inexpensive and durable and have high power, making them suitable for consumer applications. However, cadmium metal is toxic and can cause several acute and chronic health effects in humans and NiCd batteries are hazardous to the environment. NiMH batteries, which provide a less toxic alternative to NiCd, have greater energy than lead-acid batteries and have been used in automotive applications, such as the Toyota Prius HEV model. Some NiMH batteries are light and have a fast charge rate, which makes them appropriate for use in portable products. However, NiMH batteries lack the energy density to make them practical for many PHEV and EV applications.

    Conventional Lithium-ion Technologies.  Lithium-ion batteries have higher energy density than lead-acid, NiCd or NiMH batteries and can be made smaller and lighter than these batteries. After their commercial introduction in the early 1990s, lithium-ion batteries were adopted quickly for

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      small portable electronics applications such as cell phones and laptop computers. However, until recently, lithium-ion technology was not widely used other than for small portable device applications due to limitations on their power, safety and life. Furthermore, the world's supply of cobalt, a metal used in most conventional lithium-ion batteries, is more limited than the supply of other metals used in advanced lithium-ion batteries.

    Advanced Lithium-ion Batteries.  In the late 1990s, a new generation of lithium-ion chemistries capable of delivering improved performance emerged. Some of these technologies offered greater power. Other technologies introduced improvements in safety and battery life relative to conventional lithium-ion batteries. In addition, the development of lithium-ion polymer technology, utilizing modified chemistries and manufacturing methods, allowed a range of flat, or prismatic, battery shapes to be manufactured. However, existing limitations in the areas of safety and life prevented the widespread use of lithium-ion in large, high-power applications. Though some advanced lithium-ion batteries are safer than conventional lithium-ion, protective measures to prevent overcharge-related safety issues remain necessary. Furthermore, battery systems such as those being developed for HEV, PHEV and EV powertrains require not only higher levels of power and/or energy, but also the ability to function over a wide range of temperatures and a longer calendar life. For example, portable electronic devices only require about 300 to 400 recharge cycles and a calendar life of about three years, whereas typical vehicle applications require several hundred thousand shallow recharge cycles for HEV applications and several thousand deep cycles for PHEV and EV applications, with a calendar life of approximately ten years.

    Other Technologies.  Other technologies such as ultra capacitors and fuel cells have been considered as potential alternatives to batteries. Ultra capacitors are energy storage devices that deliver high power and have a long cycle and calendar life. However, they lack sufficient energy density to meet the needs of most battery applications. Fuel cells generate energy locally by consuming a fuel, usually hydrogen. Fuel cell systems currently offer similar energy density to advanced lithium-ion batteries, and may eventually be capable of greater energy density, but fuel cell systems typically have lower power and shorter calendar life. Moreover, hydrogen must be replenished after use, is difficult to store and distribute, and is currently procured in energy-inefficient ways.

Our Solution

        We believe our batteries and battery systems overcome the limitations of other currently available lithium-ion formulations and non-lithium-ion battery technologies. Our solution is based on proprietary nanophosphate chemistry originally developed by one of our founders, along with others, at the Massachusetts Institute of Technology and exclusively licensed to us. We continue to innovate our battery chemistry by improving our existing nanophosphate chemistry and exploring new material chemistries. Our battery chemistry is supplemented with innovative battery designs as well as systems and pack technologies that increase the performance and scalability of battery systems used for high-power applications. As a result, while other battery technologies offer competitive performance in some metrics, we believe our batteries and battery systems deliver superior performance by combining the following key characteristics:

    High power.  Our proprietary battery chemistry and design enable high electric power comparable to that available from ultra capacitor technology. For example, we developed an ultra high power battery for Mercedes-Benz HighPerformanceEngines for use by the Vodafone McLaren Mercedes team that delivers more than ten times the W/kg as compared to the power delivered by the battery used in a standard Prius.

    High useable energy.  Because our batteries maintain high power over a wide range of charge levels, our batteries provide more useable energy for a given size than many batteries based on other chemistries.

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    Improved safety.  Our batteries are more resistant than conventional and other advanced lithium-ion batteries to failures such as fire and explosion under certain conditions, including overcharge, overheating and physical damage.

    Long cycle and calendar life.  Our batteries are designed to retain their power and energy over thousands of recharge cycles and for up to ten years of calendar life, allowing them to meet or exceed customer requirements in our target markets.

    Fast charge capability.  Our proprietary battery chemistry and design enable some of our batteries to reach 90% charge from a fully discharged state in as few as six minutes.

    Reduced size and weight.  The high power and high usable energy exhibited by our batteries allow us to design smaller and lighter battery systems using fewer batteries to meet an application's power and energy needs. In addition, our stable battery chemistry reduces the need for control electronics that add to the battery system's size and weight.

    Low power degradation over life.  Our batteries lose less storage capacity than many competing batteries after repeated charging and exposure to high operating temperatures. As a result, we have to add less excess capacity to our battery systems in order to account for power degradation over calendar life and still meet minimum end-of-life power requirements.

    Compelling balance of cost and performance.  Our batteries are cost efficient in multiple areas. Lithium and other key materials used in our batteries are in readily available supply. The stability of our nanophosphate chemistry can require less complex and hence cheaper control circuits at the system level compared to those used in other lithium-ion batteries. Furthermore, our batteries' higher power and energy density and lower power degradation can result in deployment of fewer batteries to meet specified application requirements.

    Environmental benefits.  Unlike many other batteries, the active materials in our nanophosphate batteries do not contain nickel or manganese compounds which are classified as toxic by the EPA in the Toxics Release Inventory. In addition, at the end of their useful life for a particular application, it may be possible to re-purpose our batteries for other applications, which maximizes the use of raw materials and resources. In addition, a significant portion of our battery's materials can be recycled when the battery is no longer in use.

Our Competitive Strengths

        We believe the following combination of capabilities distinguishes us from our competitors and positions us to compete effectively and benefit from the expected growth in the advanced energy storage market:

    Materials science and development expertise.  Our proprietary materials formulations and coating techniques allow us to adjust the characteristics of our battery components to meet different energy and power requirements across our many applications. For example, we have developed new battery components that operate in temperature environments ranging from -30°C to over 60°C. Our core materials science has been successfully taken from the research laboratory to the mass market, where it has been validated in high-volume production. We plan to continue to commercialize products based on our core materials and to explore a variety of next generation chemistries that are intended to provide even higher energy and power combinations without sacrificing battery safety or life.

    Battery design capabilities.  We have been an innovator in the packaging of lithium-ion batteries. For example, we believe we were the world's first mass producer of cylindrical, aluminum, laser-welded packaged batteries. Prior to this development, most cylindrical batteries used crimped steel cans and internal mechanical designs that are heavier, have more difficulty delivering high currents, and are more permeable to humidity than our design. These capabilities allow us to introduce optimal packages in various forms and sizes designed to deliver our technology into many different

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      applications. Over the past 18 months, we have introduced and/or are developing several new cylindrical battery models for diverse applications as well as several new prismatic, or flat rectangular, battery models targeted at the automotive market. Prismatic batteries offer improved battery density and provide a higher ratio of electrically active surface area to volume, leading to improved overall power.

    Battery systems engineering and integration expertise.  A battery system typically includes a battery management system, battery supervisory circuits, state of charge algorithms, thermal management and power electronics. We have developed systems engineering and integration expertise in all of these areas. These capabilities allow us to customize our batteries and deliver fully-integrated systems, which are necessary to compete successfully in certain end markets. In addition, our system integration expertise allows us to understand system level requirements and inform our chemistry development process. It also provides us with the necessary expertise to partner with leading system integrators, understand their design requirements and assist them in developing solutions that take advantage of our battery products. We believe our system engineering capabilities accelerate the adoption of our technology across our target markets by reducing the development and integration efforts of our system integration partners and end customers. We have two groups with integration capabilities located in Hopkinton, Massachusetts (electric grid services and heavy duty transportation), and Novi, Michigan (passenger vehicles and our Hymotion PHEV modules).

    Vertical integration from battery chemistry to battery system design services. We provide a broad spectrum of highly customized solutions to our partners and customers. Our vertical integration from batteries to battery systems has allowed us to develop flexible technology modules at every step of battery development, including a scalable prismatic battery system architecture that allows common modules to be configured according to varied transportation customer requirements. The ability to work with partners and customers across the design process provides us with a better understanding of customer needs and allows us to customize our modules and design steps to their specific requirements. This understanding of our customer needs often reduces our development time because we can address design requirements at the chemistry, battery or battery system levels. Furthermore, by managing each design step from battery to battery system, we can better protect our intellectual property.

    Industry-leading partners in focused markets.  We work closely with leaders in each of our target markets, such as AES, BAE Systems, BMW, Chrysler, Daimler, Better Place, SAIC and Gillette. We have entered into agreements relating to joint design and development efforts with several major passenger vehicle manufacturers and tier 1 suppliers, including Chrysler for the ENVI electric vehicle program and BMW for its HEV program. We also continue to work with General Electric to draw on their research and technology development expertise in our target markets. We believe our experience with our development partners provides us with a significant research and development advantage, greater access to end customers, market credibility and additional avenues to secure supply contracts.

    High-quality, volume manufacturing facilities and proprietary process technologies.  We have over 450,000 square feet of manufacturing facilities in China, Korea, Michigan and Massachusetts. Our internal manufacturing operations provide us with direct control over the quality of our products and improve the protection of our materials science, systems and production process intellectual property. In addition, we believe our manufacturing control allows us to rapidly modify and adapt standard equipment for our particular production requirements, thereby reducing our overall development time to market. Over the past several years, we have developed high-volume production expertise and replicable manufacturing processes that we believe we can scale to meet increasing demands for our products. We are compliant with ISO 9001:2000 certification and are pursuing TS16949 certification.

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Our Strategy

        Our goal is to utilize our materials science expertise, our battery and battery systems engineering expertise and our manufacturing process technologies to provide advanced battery solutions. We intend to pursue the following strategies to attain this goal:

    Pursue markets and customers where our technologies create a competitive advantage.  We will continue to focus our efforts in markets where customers place a premium on high-quality batteries, innovation and differentiated performance. We believe our battery technologies, our design and systems expertise and manufacturing processes, provide us with a competitive edge in enabling new battery applications that address challenging design constraints and demanding performance requirements.

    Partner with industry leaders to adapt and commercialize our products to best meet the requirements of our target markets.  In each of our target markets, we have entered into joint development and supply agreements with industry-leading companies. These relationships provide us insight into the performance requirements of that market, allow us to share product development costs, and position our products to serve as a key strategic element for our partner's success. We intend to continue to pursue partnerships in our target markets to enhance our product offerings and to facilitate expansion into new geographies.

    Actively pursue federal and state incentive funding for battery development, facility expansion and job creation.  We intend to take advantage of U.S. government and state programs established to increase domestic investment in the battery industry. To date, we have been awarded a $249.1 million grant under the DOE Battery Initiative and have applied for a federal loan to support our manufacturing expansion in the United States. We have received approximately $3 million from the State of Michigan to date under a $10 million Center of Energy Excellence grant, with the remainder to be paid based on the achievement of certain milestones in our facility development such as the installation of purchased equipment and qualification of manufacturing processes. We are also discussing other funding opportunities with the Commonwealth of Massachusetts.

    Expand our manufacturing capacity in the United States.  If we receive sufficient federal and state incentive funding and the actual and anticipated future demand for our products increases as expected, we plan to expand our domestic battery manufacturing capacity. Our plan involves building vertically integrated manufacturing plants in the United States that encompass the full production process, including the manufacturing of our proprietary cathode powder, electrode coating, battery fabrication and the assembly of complete battery systems ready for vehicle integration.

    Remain on the forefront of innovation and commercialization of new battery and system technologies.  We intend to continue to innovate in materials science and product design to enhance the benefits of our product offerings. This innovation will be derived from our internal research and development efforts, from our close development partnerships with our customers and from licensing or acquiring new technologies developed by third parties. We maintain relationships with top industry leaders, government labs and universities to advance research and to track promising developments and technologies.

    Reduce costs through manufacturing improvements, supply chain efficiencies and innovation in materials.  We intend to lower our manufacturing costs by improving our manufacturing performance and lowering our materials cost. As we continue to grow, we are focused on increasing the yield in our manufacturing and improving our margins as production volumes increase. We also manage our working capital requirements in manufacturing through inventory management and additional supply chain efficiencies. In addition, we continuously evaluate how to improve our product offerings and lower costs through further materials innovation. We are actively developing new materials with properties we believe will allow us to build batteries that require fewer control and electronic components and enable our battery systems to maintain or improve performance at a lower cost.

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Our Products

        Our current product offerings include batteries in various sizes and forms as well as packaged modules and fully-tested battery systems. The platform for battery and battery system development is our patented nanophosphate material, which can be engineered to meet the strict requirements of a broad set of applications in our target markets.

    Batteries

        We currently offer a portfolio of batteries based on our nanophosphate technology for application development in the transportation, electric grid services and consumer markets, as summarized below:

    GRAPHIC   GRAPHIC   GRAPHIC   GRAPHIC   GRAPHIC   GRAPHIC

Product

 

APR18650

 

ANR26650

 

AHR32113
Gen 1

 

AHR32113
Gen 2

 

Prismatic
HEV

 

Prismatic
EV/Extended
Range EV

Nominal capacity* (Ah)

  1.1 Ah   2.3 Ah   3.6 Ah   4.4 Ah   6 Ah   19-20Ah

Energy (Wh)

  3.6 Wh   7.6 Wh   11.9 Wh   14.5 Wh   19.8 Wh   62-66 Wh

Power to energy ratio

  Medium   High   Ultra high   Ultra High   Ultra High   Medium

Electrode type**

  M1   M1   M1 Ultra   M1 Ultra   M1 Ultra   M1 HD

Status

  Volume production   Volume production   Volume production   Prototype
production
  R&D Prototype   Prototype
production

Applications

  Consumer and Professional Consumer Applications   Consumer, Hybrid Transit Buses, Electric Vehicles, Electric Grid Services   Hybrid Electric Vehicles, Hybrid Transit Buses and Heavy Duty Hybrid Electric Vehicles   Hybrid Electric Vehicles, Hybrid Transit Buses and Heavy Duty
Hybrid Electric Vehicles
  Hybrid Electric Vehicles, Hybrid Transit Buses and Heavy Duty Hybrid Electric Vehicles   Extended Range Electric Vehicles, Plug-In Hybrid and Electric Vehicles

*
The capacity of a battery is the amount of charge it can store, typically given in units of amp hours, or Ah.

**
We have developed several electrode technologies based on our nanophosphate chemistry for our batteries depending on their application. M1 offers a combination of energy and power. M1 Ultra is designed for high power applications. M1 HD is designed for high energy applications.

APR18650. The APR18650 (18 mm in diameter, 65 mm in height) has a similar design as the ANR26650, but comes in a smaller, industry-standard package. This battery is currently used in DeWalt's 18 V Nano line of power tools. We plan to continue producing this battery through partnerships with third-party suppliers rather than build our own production capacity.

ANR26650.  We originally developed the ANR26650 (26 mm in diameter, 65 mm in height) for DeWalt's 36 V series of professional power tools. This battery offers a combination of power and energy that allows it to be used in a diverse set of applications, including power tools, BAE Systems' Hybridrive system for the Orion VII hybrid-electric bus and AES's Hybrid-APUs.

AHR32113.  The AHR32113 (32 mm in diameter, 113 mm in height) is designed for high-power HEV applications and to offer significantly higher power than our consumer batteries. The AHR32113 is designed to address markets where power is the main requirement and where cost per unit of power is the key metric. We have developed a new version of the AHR32113, Gen 2, to meet specific customer requirements. The Gen 2 version offers higher power and capacity and is further optimized for high volume manufacturing.

Prismatics.  We are currently developing several prismatic batteries for PHEV and EV applications. Our building block for PHEV and EV applications, currently in low-volume manufacturing, is the 20Ah prismatic cell.

Specialty Cylindrical Cell.  Our smallest and most advanced automotive class battery (not shown on the above chart) is a custom battery developed for the Vodafone McLaren Mercedes team,

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      currently in use in the 2009 racing season. We believe this battery is the highest specific power lithium-ion production battery ever built for use in high performance racing applications.

    Battery Systems

        Our energy solutions group offers a variety of fully packaged systems as well as sub-module building blocks for battery system development. Our development of integrated systems includes not only the packaging of our batteries, but also power electronics, safety systems, thermal management, testing, production and qualification. We design standard systems as well as custom systems using a modular design based on standard building blocks. We manufacture a variety of battery systems, in which batteries are connected in various configurations to meet the design requirements of specific applications. The following are examples of a modular building block based on our 32113 HEV cells and various module designs using our scalable 20Ah prismatic cells.

GRAPHIC

        Our prismatic battery system's design allows for various battery configurations, providing pack design versatility for the automotive market. This design reduces retooling time when reconfiguring our assembly lines for different customers. Our battery systems are highly engineered to incorporate safety and control features that extend life and improve performance. Module-level fusing, temperature sensing and other safety controls provide additional containment safeguards to isolate and protect against cell-level failure. Active overvoltage protection provides monitoring and balancing of individual series elements to protect cells from abuse and to extend life. These battery systems are designed to accommodate either liquid or air-cooled thermal management systems, and have mechanical structures designed to withstand the harsh vibration and mechanical shock environment of automotive applications.

        Current product offerings include the following:

    BAE Systems Energy Storage Solution.  We produce an energy storage solution for BAE Systems' HybriDrive drive train for the Orion VII hybrid-electric bus. This 180 kW system incorporates our ANR26650 batteries into sub-modules that include a redundant, fault-tolerant design. Air-cooled

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      with safety systems designed in, this energy storage solution reached volume production in 2008 as a replacement for a lead-acid solution that weighs approximately three times as much as our solution, with half the expected life.

    Hymotion L5 Battery Range Extender Module.  Through our Hymotion brand, we offer an aftermarket conversion module to augment the performance of a standard Toyota Prius HEV through the 2009 model year, turning it into a PHEV capable of over 100 miles per gallon. This module provides fleets and consumers with a PHEV option.

    Grid Service System.  We have developed multi-megawatt battery systems for AES capable of performing ancillary electric grid services, including standby reserve capacity and frequency regulation services.

    Prismatic Module.  We are working with Chrysler and other manufacturers such as Better Place and Daimler to develop and supply prismatic battery systems.

Technology Overview

        Lithium-ion batteries are rechargeable batteries in which lithium is reversibly transported through a nonaqueous liquid electrolyte, or ionically conductive medium, between positive and negative electrodes that store lithium in the solid state. Lithium-ion batteries are distinguished from disposable lithium batteries, or rechargeable lithium metal batteries, by not utilizing metallic lithium as a negative electrode material. Instead, both electrodes utilize compounds in which lithium atoms may be stored at relatively high concentrations without forming lithium metal, an attribute that is key to safe and prolonged recharging. The non-aqueous electrolyte in lithium-ion batteries allows operation at a high voltage (about 2.5-4.4 V for current technology) without suffering electrolyte decomposition. The combination of a high voltage and high charge storage capacity in both the positive and negative electrodes provides for the high specific energy (50-230 Wh/kg) and energy density (100-450 Wh/liter) of current lithium-ion batteries. These energy values span a wide range for several reasons. Batteries designed for high power typically utilize thin electrode coatings which result in lower overall active materials content and therefore lower energy. The energy per mass and per volume also varies with form factor, cylindrical batteries typically having higher values than prismatic batteries, and battery size, smaller batteries typically having lower values due to higher packaging factor. Importantly, the choice of positive and negative electrode materials has a large impact on the energy that can be stored and the power that can be delivered using a specific battery.

        We are primarily focused on developing a new generation of lithium-ion batteries and battery systems to serve applications and markets outside the historical domain of lithium-ion. These applications include HEVs, PHEVs and EVs, electric grid ancillary services, and power tools. These applications frequently require battery systems having much higher total energy or power outputs than required by previous lithium-ion applications, and place a premium on one or more of the attributes of high energy, high power, improved safety, and long life. We also maintain an active research and development effort to develop future generations of materials for several key components of battery systems, and improved battery and battery systems designs to take advantage of the attributes of those materials.

Customers and Development Partners

        Our primary customers and development partners are industry-leading companies that value and require high battery performance. Our customers and development partners span multiple industries and include the following organizations in our target markets:

    Transportation.  We are currently working under non-exclusive arrangements with major global automotive manufacturers and tier 1 suppliers to develop batteries and battery systems for the HEV, PHEV and EV markets. In April 2009, we entered into a supply agreement with Chrysler to develop and supply prismatic battery systems for use in Chrysler's ENVI electric vehicle program

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      across several vehicle platforms and models. Under our agreement with Chrysler, Chrysler may issue purchase orders to us for battery systems to be used in Chrysler's designated electric vehicle production programs based on forecasted planning volumes at the unit prices and warranty terms included in the agreement. There are no volume guarantees or minimum volume commitments under this agreement. We have also been selected by, and are currently negotiating a supply agreement with, BMW to supply HEV batteries, and we have entered into a development agreement with Delphi to develop battery systems for a mass-produced SAIC HEV in China. We are also currently negotiating development agreements with SAIC to develop a demonstration battery system for an EV and a battery system for a PHEV. We entered into a joint development agreement with GM in August 2007 to jointly develop and produce prototype quantities of a proposed lithium-ion prismatic battery for GM vehicles. While we are in discussions with GM regarding additional lithium-ion batteries for HEV and PHEV programs, we do not have a commitment from GM on any vehicle platforms. Under our May 2008 joint development contract with BMW, we developed lithium-ion batteries for use in HEV battery systems. We subsequently entered into a warranty agreement with BMW in May 2009 for HEV batteries that we expect BMW to purchase from us, and we are negotiating a supply agreement with BMW which will provide the terms and conditions under which BMW may purchase HEV batteries from us. Under our supply agreement with Mercedes-Benz HighPerformanceEngines, which we entered into in September 2007, we exclusively developed and supplied batteries for the Vodafone McLaren Mercedes team for use through the 2009 racing season. Our other automotive development partners include tier 1 suppliers, such as Magna Steyr, major automobile manufacturers and EV manufacturers, such as Renault, and network operators such as Better Place, which provides EVs with lithium-ion battery systems that can be easily recharged or switched through a network of charge locations and battery switch stations. Our March 2009 supply agreement with Magna Steyr provides for an initial seven-year term during which Magna Steyr may order batteries from us based on a monthly forecasts over a rolling three-month period. Under our supply agreement with Better Place, which we entered into in September 2008, Better Place has ordered prototype battery systems at agreed pricing and warranty terms. In the heavy-duty vehicle market, we are supplying battery systems to BAE Systems pursuant to a May 2007 development and supply contract. BAE Systems is initially using our battery systems in its HybriDrive propulsion system, which is currently being deployed in Daimler's Orion VII hybrid electric buses. We have also been selected by, and are currently negotiating a contract with, Daimler to supply battery systems for use in systems developed by Daimler's EvoBus subsidiary.

    Electric Grid Services.  We have developed multi-megawatt battery systems for AES capable of performing ancillary electric grid services, including standby reserve capacity and frequency regulation services. We have developed and installed a two megawatt Hybrid-APU for a pilot program with AES in California. This unit is operational and is performing ancillary grid services in a limited test mode, with full-time commercial deployment anticipated by the end of 2009. We have shipped additional units for AES, totaling 16 megawatts, which are currently in the installation and commissioning process. Our agreement with AES provides that AES shall purchase up to 25 Hybrid-APUs, either directly or through designated affiliate companies.

    Consumer.  We have entered into license and materials supply agreements with Gillette pursuant to which we granted Gillette an exclusive license to certain of our technology and are supplying materials to Gillette for use in their consumer products (excluding power tools and certain other consumer products). Black & Decker has developed a number of product lines using our batteries. We are also considering opportunities in emerging applications, including lawn and garden tools, vacuums and medical devices. In addition, we are developing and selling products for consumer applications, selling primarily through a network of global distributors.

        We also sell our batteries and battery systems directly to end-user customers as well as through reseller and distributor channels.

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        Under our agreement with AES, we have agreed to work exclusively with AES on the development and deployment of grid service systems and new product lines through December 31, 2009. This exclusivity period will extend beyond December 31, 2009 for so long as we elect to receive, and do receive, exclusivity payments from AES as provided for in the agreement.

        Under our agreement with Black & Decker, we have agreed to sell our battery packs exclusively to Black & Decker for use in professional power tools and accessories, provided that Black & Decker either meets certain purchase requirements or otherwise makes certain payments to us in order to maintain exclusivity. In addition, during this exclusivity period, we have agreed that we will not provide batteries to other parties for use in certain consumer fields without first offering the development opportunity to Black & Decker.

        Under our exclusive license agreement with Gillette, Gillette paid us an up-front fee of $22.5 million and a support fee of $2.5 million during 2008. Gillette will also be required to pay us an additional license fee following the completion of a support period. In addition, the agreement requires Gillette to pay us royalty fees on net sales of products that include our technology. We have agreed with Gillette that if, during a certain period following execution of the license agreement, we enter into an agreement with a third party that materially restricts Gillette's license rights under the license agreement, then we may be required to refund to Gillette all license and support fees paid to us by Gillette under the license agreement, plus, in certain cases, an additional amount to cover Gillette's capital and other expenses paid and/or committed by Gillette in reliance upon its rights under the license agreement.

Government Initiatives and Contract Research

    Federal Government

        In February 2009, the U.S. government enacted the ARRA, which provides for $2 billion in grants under the DOE Battery Initiative to support the construction and capacity expansion of U.S. manufacturing plants to produce batteries and electric drive components for HEV, PHEV and EV vehicles. In August 2009, the U.S. government announced that we have been selected to receive a $249.1 million grant award under the DOE Battery Initiative to support our manufacturing expansion.

        We have also applied for direct loans under the DOE ATVM Program to support this manufacturing expansion. Based on the amount of our grant award under the DOE Battery Initiative and the guidelines associated with the ATVM Program, we believe we will be permitted to borrow up to $235 million under the ATVM Program. Under the DOE Battery Initiative, we will be required to spend up to one dollar of our own funds for every incentive dollar we receive, and we expect we will be required to spend one dollar of our own funds for every four dollars we borrow under the ATVM Program. The timing and the amount of any loan we may receive under the ATVM Program, as well as the specific terms and conditions applicable to our grant award under the DOE Battery Initiative or any loan we may receive, are currently not known by us, and, once disclosed to us, are subject to change and negotiation with the federal government.

    State of Michigan

        We have received approximately $3 million from the State of Michigan to date under a $10 million Center of Energy Excellence grant, with the remainder to be paid based on the achievement of certain milestones in our facility development such as the installation of purchased equipment and qualification of manufacturing processes. The State of Michigan has also offered us up to $4 million in low interest loans as an incentive to establish a lithium-ion battery manufacturing plant. We intend to use these funds to support our planned expansion in Livonia, Michigan. In addition, in April 2009, MEGA granted us a credit for 50% of our capital investment expenses, up to a maximum of $100 million over a four-year period, related to the construction of an integrated battery cell manufacturing plant, which we intend to build if we receive adequate funds from the DOE. We must create at least 300 jobs at the plant in order to receive this

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credit. MEGA has also offered us a 15-year tax credit, beginning with the 2011 fiscal year, having an estimated value of up to $25.3 million, depending on the number of jobs we create in Michigan. We are seeking other incentives from the State of Michigan, including designation of our site selection as a "Renaissance Zone", which would provide potential tax benefits if approved.

    Massachusetts

        We are seeking rebates, tax exemptions, tax credits and financing that the Commonwealth of Massachusetts has offered to support the expansion of our facilities in Massachusetts. The availability of these incentives will be subject to the completion of applications, compliance with program requirements and the negotiation of applicable agreements.

    Contract Research

        We have received awards from the Department of Energy's collaboration with the United States Advanced Battery Consortium, or USABC. In December 2006, we commenced the HEV battery development program with the USABC. It is a $15 million program, with a 50-50 cost share whereby the USABC will provide us up to $7.5 million, designed to accelerate development of a high-performance, low cost HEV battery. This program will end in December 2009. The second A123 USABC program is a $12.5 million program, also with a 50-50 cost share, with a goal of developing high-energy, low cost PHEV batteries. Under this program, we are targeting the development of two different kinds of PHEV batteries, one with ten miles of electric equivalent range and the other with 40 miles of electric equivalent range.

Manufacturing

        Our global supply chain and manufacturing infrastructure can produce millions of batteries and hundreds of tons of active materials per year. We measure our product shipments in watt hours, which is the energy capacity of a single battery for a single complete discharge.

        Watt hours, or Wh, are the amp hour storage capacity of a battery multiplied by its voltage. The average battery voltage for our 26650 battery is 3.3 volts, or 3.3 V. We determine amp hour storage capacity at a specific discharge rate and a specific depth of discharge. We do this by charging the battery to its top voltage and discharging it to zero capacity (2 volt charge level). A battery's usable energy capacity is determined at the application level. For example, our 26650 battery has a nominal capacity of 2.3 Ah and operates at 3.3 V, resulting in 7.59 Wh.

        As of June 30, 2009, we estimate that our annual manufacturing capacity was approximately 169.3 million watt hours.

        We have over 450,000 square feet of manufacturing facilities worldwide where we produce or intend to produce our batteries, from raw powder to finished batteries and battery systems using both our facilities and third party contractors. Our primary manufacturing facilities are located in Changzhou, China in an export processing zone. We produce our prismatic batteries at our facilities in Korea and Chanchun, China. We also have the capability to manufacture and assemble low volume, high value-add battery modules and systems at our energy solutions group facility in Hopkinton, Massachusetts. We produce our specialty cylindrical batteries for Mercedes-Benz HighPerformanceEngines at our Watertown, Massachusetts R&D facility.

        We commenced commercial production of powder in the third quarter of 2005 and outsourced the coating and battery and battery system assembly. Initial battery production ramp-up commenced in the third quarter of 2005 and our first commercial batteries began shipping in February 2006. During 2007, we commenced construction of two additional plants for the expansion of powder production and new coating production and signed a lease for a third plant for new battery assembly at our Changzhou location. We completed the qualification of these plants for full volume production in 2007.

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        While our current concentration of manufacturing facilities is in Asia, we plan to aggressively expand our domestic battery manufacturing capacity by establishing vertically-integrated manufacturing plants in the United States that would perform all of the stages of the manufacture of batteries and battery systems. Our planned U.S. expansion depends upon our receipt of sufficient federal and state incentive funding and is intended to complement our existing manufacturing facilities in Asia. The goal of this expansion, which would occur gradually and over several years, is to significantly improve specific operational output in powder, coating and cell assembly.

        The first phase of this expansion is taking place in Livonia, Michigan, where we intend to produce prismatic and cylindrical cells and systems using the same processes and equipment we currently use in our Asian factories. We are in the process of identifying several other facilities for lease which would be designed for high-volume manufacturing and where we would utilize fully-automated manufacturing equipment and facilities controls systems.

        The manufacturing of our batteries and systems requires several integrated stages: powder synthesis, cathode and anode coating, battery and battery system assembly. We continue to augment the degree of automation in each of these stages, transitioning from semi-automated production lines, to production lines with fully automated process bays and high volume equipment, where the only manual steps consist of loading and monitoring equipment and performing certain quality control processes.

        Our manufacturing operations allow us to directly control product quality and minimize the risks associated with having to disclose proprietary technology to outside parties during production. In Asia, to further protect our intellectual property, we use separate manufacturing facilities for each phase of battery production. We control every stage in the manufacture of our products except for the final assembly of our 18650 batteries and certain battery coating operations, which we currently outsource to Asia-based sub-contractors.

        Our powder, coating and assembly facilities incorporate environmental control and processing systems in a modular design geared for easy and rapid capacity expansion. To complete each new production line, we plan to use a systematic replication process designed to enable us to add production lines rapidly and efficiently and achieve operating metrics in new production environments that offer comparable performance to that of our current plants.

        We also are seeking to lower our manufacturing costs and to improve our cost per Wh manufactured by refining processes and intermediate quality control to improve manufacturing yields, obtaining raw material and component volume discounts, consolidating sub-contractors, substituting certain raw materials, managing inventory and optimizing shipping costs. While our manufacturing philosophy is designed to achieve low cost in order to maintain sustainable competitive advantage, it is also focused on providing world class quality. We are compliant with ISO 9001:2000 certification and are pursuing TS16949 certification for late 2009.

Sales and Marketing

        We market and sell our products primarily through a direct sales force, consisting of individuals who have backgrounds in either electrical or mechanical engineering and who generally have experience selling batteries and battery systems into the specific market segments to which they are assigned. In the transportation market, we are focusing sales of our batteries and battery systems to automotive manufacturers either directly or through tier 1 suppliers. We are working with automotive manufacturers directly to educate and inform them about the benefits of our technology for use in HEVs, PHEVs and EVs. At the same time, we are working with tier 1 suppliers who are developing integrated solutions using our batteries.

        In the electric grid market, our initial sales to AES have been made directly through our sales force. In the consumer market, our sales are made both directly and indirectly through distributors with key accounts managed by our sales personnel. We also have value added partners in the United States, Europe,

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and Asia who integrate our products into consumer applications. Our indirect channel sales are made primarily through these value-added distributors and sales representatives in North America, Europe and Asia which focus on non-major customer accounts.

        Our direct sales force is based in the United States and Europe. We are expanding our sales presence in the United States and Europe and are seeking to expand our presence in Asia as our business in those regions continues to develop. We expect international markets to provide increased opportunities for our products.

        We may enter into strategic relationships with business partners based in Europe, China and Japan who have complementary technologies for, and experience in, the transportation and other markets. We believe that forming such relationships could help to achieve cost economies in product development and manufacturing, provide us with the ability to take advantage of any available local government stimulus funding and related incentives, result in optimized products and provide advantages in marketing and selling our products in the geographic markets where our partners are based.

        Our sales cycles vary by market segment and typically follow a lengthy development and qualification period prior to commercial production. For example, in the automotive market, a customer's preliminary technology review generally ranges from three to twelve months and product development generally ranges from twelve to eighteen months. We expect that the total time from customer introduction to commercial production will range from three to five years depending on the specific product and market served. In the electric grid services market, our initial test system development for AES has taken approximately nine months, and we expect that the initial production systems will take an additional six to twelve months to be manufactured, shipped and installed. In the consumer market, the time from introduction to commercial production can take up to three years or more.

        We focus our marketing efforts on increasing brand awareness, communicating product advantages and generating qualified leads for our sales force and channel partners. We rely on a variety of marketing vehicles, including participation in industry conferences and trade shows, to share our technical message with customers, as well as public relations, industry research and our collaborative relationships with our strategic investors and business partners.

        As of August 31, 2009, we had 25 employees in sales and marketing, including 11 sales professionals.

Research and Development

        Our research and development efforts are focused on developing new products and continuously improving the performance of existing products. We design our products for performance metrics such as energy density (the amount of energy per volume of the battery), specific energy (the amount of energy per mass of the battery), power density (the amount of power per volume of the battery) and specific power (the amount of power per mass of the battery), cycle life, calendar life and numerous safety and abuse-tolerance metrics. We focus our research and development efforts on the following areas:

    Improving the energy, power, life and safety of key electrode-active materials.  At our Watertown, Massachusetts and Ann Arbor, Michigan facilities we devote substantial efforts to developing new compositions and structures of cathode and anode materials and low-cost processes for synthesizing these materials. These compositions and processes are validated at laboratory and pilot-plant scales before being transitioned to our high-volume manufacturing facilities.

    Developing battery component formulations and chemistries.  The optimization of lithium-ion batteries requires consideration of interrelated electrical, chemical and mechanical phenomena that occur within batteries during field use. We develop proprietary cathode and anode formulations and coating procedures, as well as proprietary electrolyte compositions that are evaluated along with other critical components to arrive at complete battery designs.

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    Electrical, mechanical, and thermal design.  Physical battery design is an important consideration for the sealability, durability, cooling and abuse-tolerance of lithium-ion batteries, especially those used in large high-power battery systems. We have and continue to develop innovative constructions for our cylindrical and prismatic battery products. This development work takes place across several of the company's research and development and manufacturing facilities in the United States, China and Korea.

    Battery systems-level design.  We develop battery systems that can be used by a number of customers, and we work with our customers to develop customized battery systems for specific applications. We have also developed a modular and highly scalable battery system design for our prismatic battery systems. This work takes place primarily within our energy systems group, at facilities located in Hopkinton, Massachusetts and Novi, Michigan. We intend to transfer the work conducted at our facility in Novi, Michigan to our new facility in Livonia, Michigan in late 2009.

        We believe that our ability to deliver higher performance batteries and battery systems depends upon the rapid and effective transfer of the technology developed in our research and development laboratories into high volume manufacturing. Therefore, we maintain pilot plant capabilities at our Massachusetts and Michigan facilities, and we reserve a portion of our production capacity for structured experiments related to manufacturing process development.

        As of August 31, 2009, we had 217 research and development employees worldwide.

Universities and National Laboratories

        An important part of our overall research activities are our relationships with universities and national laboratories. We maintain active collaborations with the Massachusetts Institute of Technology relating to electrode materials for batteries used in transportation applications, the University of Michigan relating to the development of manufacturing technology designed to support transportation applications, Michigan State University relating to the development of materials technology designed to support next generation battery cell products, and The University of Texas relating to electrochemical and thermal cell modeling designed to support transportation applications, as well as several U.S. Department of Energy laboratories, including Lawrence Berkeley National Laboratory relating to investigating the life of lithium-ion batteries, Argonne National Laboratory relating to validating cell performance test results conducted for USABC in transportation applications, Idaho National Laboratory relating to evaluating our Hymotion L5 battery modules in transportation applications and the National Renewable Energy Laboratory relating to validating thermal cell testing activity and module level thermal modeling. Some of these collaborations take place under the auspices of the USABC, which is comprised of Chrysler, Ford and GM. Since inception through June 30, 2009, we have invested $109.0 million into our research and development activities of which we have been reimbursed through government grants for $9.6 million. We also received $20.3 million from U.S. government agencies for research and development services. As of June 30, 2009, we have committed to invest an additional $7.3 million for the USABC programs of which we expect to be reimbursed for $3.6 million.

Competition

        Competition in the battery industry is intense and rapidly evolving. Our markets are subject to changing technology trends, shifting customer needs and expectations and frequent introduction of new technologies. We believe the primary competitive factors in our markets are:

    product performance, reliability and safety;

    integrated solutions;

    product price; and

    manufacturing capabilities.

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        We have recently begun facing competition from joint venture companies in our industry. For example, in 2008, Bosch and Samsung formed LiMotive to focus on the development, production and marketing of lithium-ion battery systems for use in HEVs and other electric vehicles. Dow Chemical has recently announced the establishment of a joint venture with Kokam America and others, pending receipt of government incentive funding, to build a facility in Michigan for the manufacture of lithium polymer batteries for use in HEVs and other electric vehicles.

        In the rechargeable battery market, the principal competitive technologies currently marketed are lead-acid, nickel-cadmium, nickel metal hydride and lithium-ion batteries. Our primary competitors who have announced the availability of either lithium-ion or other competing rechargeable battery products include Panasonic, BYD, LG, Lithium Energy Japan (Mitsubishi-GS Yuasa), Blue Energy Company (Honda-GS Yuasa), and LiMotive and Samsung, among others.

        Within each of our target markets, we encounter the organizations named above as well as other competitors:

    Transportation.  In the transportation market, our competitors in the automotive industry fall into three main categories:

    HEVs. In the hybrid space, we compete with large battery companies such as Panasonic, LiMotive, Automotive Energy Supply Corporation, or AESC, Johnson Controls-Saft Advanced Power Solutions, or JCS, Toshiba, Kokam and Hitachi, Ltd., as well as smaller competitors such Altair Nanotechnologies, Inc. or Altairnano.

    PHEVs. We compete with established companies such as LG and JCS. As the market for PHEVs is emerging, the complete competitive landscape is unknown and subject to change.

    EVs. We compete with AESC, Kokam, GS Yuasa, Panasonic, Sony, Lithium Energy Japan, EnerDel Inc., or EnerDel, and Valence. In addition, MES-DEA S.A. has developed a sodium-nickel chloride solution that has also been used in this particular application.

    Electric Grid Services.  In the electric grid services market, we compete with Saft and Altairnano. We also expect competition from manufacturers of other new battery technologies, such as sodium-sulphur from NGK Insulators, Ltd. in Japan and redox flow batteries under development from companies including Prudent Energy that may provide large scale energy storage for grid applications. Finally, we may encounter competition from developers of flywheel technologies, such as Beacon Power Corp. A flywheel electric grid energy storage system draws electrical energy from the utility grid and stores it in a rotating flywheel, making it available when needed at a later time through a motor-generator system.

    Consumer.  Our principal competitors in this market are Panasonic, Sony, Samsung, LG, Valence and E-One Moli Energy Corp. We also are aware of other vendors making batteries in China under a variety of different manufacturing labels for this market.

        Many of our competitors have greater market presence, longer o